Tips and Tricks of the 1031 Exchange with Dave Foster: An EOFire Classic from 2022

0:02John Lee Dumas:Who's ready to rock today, Fire Nation? JLD here, and welcome to Entrepreneurs on Fire, brought to you by High Level, the all-in-one sales and marketing platform. On today's classic episode, we'll be breaking down tips and tricks of the 1031 Exchange. To draw these value bombs, I brought to Dave Foster in the EO Fire Studios. Dave is the founder and CEO of the 1031 Investor. Dave tells us about the updated rules and regulations around using the 1031 Exchange to legally compound your tax interest that will stay with you instead of going straight to the government and oh, so much more. And a big thank you for sponsoring today's episode goes to Dave and our sponsors.

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1:19John Lee Dumas:Dave, say what's up to Fire Nation and share something that you believe about becoming successful that most people disagree with.

1:29Dave Foster:Hey, hey, hey, Fire Nation. It is awesome to be here with you, John. You know, when I was thinking about that question, I think particularly what I've seen throughout my life, because I'm now older than dirt, is that I've had to develop patience. And I think probably the thing that I see today is that the one thing that will guarantee your success more than anything else that a lot of people just can't believe is that patience and time truly are on your side. Sometimes the longer route is the faster route. But I know we live in a microwave generation, and so I'm probably the old curmudgeon.

2:11John Lee Dumas:Well, we are going to be talking about the financial side of things today. specifically about 1031. So I think that was a really good way to start it, Dave, because there's a Warren Buffett quote that I simply love is that it's not about timing the market. It's about time in the markets. And if you can be in the markets for a long time, the odds are you're going to benefit as a result. So I already gave a great introduction of you, Dave, of what we're talking about here today. I went through some of the things that we will be chatting about. I gave some teasers. So Fire Nation knows what's coming.

2:45John Lee Dumas:And I want to start off with just a crystal clear explanation of what exactly a 1031 exchange is.

2:52Dave Foster:Yeah, well, a 1031 exchange is simply a process that comes from Section 1031 of the IRS code. And it allows investors in real estate to sell their investment real estate and then purchase new investment real estate and indefinitely and I mean indefinitely, defer having to pay tax on the profit or the tax benefit of depreciation. So they get to use the deferred tax that would normally go to the government for their own benefit. And that is adding fire on top of a real estate portfolio.

3:34John Lee Dumas:Well, here at Fire Nation, we love nothing more than igniting flames, times sparking the embers, creating fire. And as you and I talked about pre-interview, Dave, we're going to keep things light. We're going to keep things fun. We are not going to get in the weeds, Fire Nation. So don't think you're sitting down for some long droning textbook conversation about 1031s. This is going to be fun. This is going to be light. Dave, can you share how you specifically have used 1031s in the past?

4:01Dave Foster:You know, that's actually how I became a qualified intermediary, one of these people that do 1031s for others, was that way back, the very first property I purchased was because my wife and I were looking to get out. We were trying, we had our first child. And kids are like TVs. Once you have one, you don't want to do anything else, but just watch them. It was amazing. And we said, if our most precious commodity is time, How can we get off the corporate trains that we're on and find a way to spend our life infesting in our children and our life with them? So like so many folks in the Fire Nation, we chose real estate as that avenue.

4:47Dave Foster:And so I just marched ahead, bought a duplex in Denver. I don't even want to think what it's worth today. But I fixed it up. I sold it. And I was so fat and sassy, John, until I went to my accountant. that winter. And he said, man, are you going to pay a lot of tax? I said, yeah, you just lost your Christmas card, buddy. But what I realized at that moment was that you and I and everybody have a silent partner in every real estate deal. And that silent partner's name is Uncle Sam. And usually he will do better than you will. And so, of course, when you've got friends like I do, they mock you mercilessly when they find out that something like this has happened.

5:31Dave Foster:But then those same friends also came alongside and said, Dave, did you know that there was a recent court law? This was back in 1996. That's going to allow investors to not have to pay that tax. And it's the 1031 exchange. I said, sign me up. And so from that moment, we had a 10-year goal to use real estate to end up buying a sailboat and moving our family on board and living on the water. And so from that moment, that's what we invested ourselves in. And here we are 23, 24 years later, and we managed to buy the sailboat. We managed to live on it for 10 years with our kids. We managed to build a real estate portfolio in several different geographical locations and have yet to pay a penny in capital gains tax.

6:19John Lee Dumas:Now, Fire Nation, if that's not a fun, exciting story, I don't know what is. I mean, that is what we call living the dream here. And I think one thing that we need to get into next day for Fire Nation to really start wrapping their heads around this process is the timeline. It's because a lot of people might think, well, I mean, do I need to, you know, have like a five, 10 year time horizon for this? Like, what are the basic timeline requirements for a 1031 exchange?

6:44Dave Foster:Yeah, so much of that, John, is going to be so specific strategically in terms of where you find yourself in your real estate career. but we am and worry this particular piece of real estate that you're considering. But let's take a look at the general 1031 aspect of it. If you've got a property that has significant appreciation or significant depreciation that you've taken, then that might be the time for the 1031. You have to use the services of a qualified intermediary. the IRS will not let you touch the proceeds and the intermediary has to be in place prior to the sale of the property. So you want to think of the 1031 as a sell then buy process.

7:33Dave Foster:It starts with the sale. And I still get calls every month from folks who said, Dave, I closed on a sale last week. I want to do a 1031. And all I can do is weep with them because it's over if the 1031 is not in place prior to the closing of the sale. So that's what starts everything. Now, from that date, you've got a couple of serious timelines. You've got 45 days to identify your potential replacements. You've got 180 days to close on it. So it's not like you can lollygag around for a long time. You've got to be very, very focused. But in today's overheated markets, being focused and quick is not a bad thing, is it?

8:13John Lee Dumas:I'm always telling my audience, be agile, be flexible, be quick, because it truly is that early bird that gets the worm. And one thing that I do want to talk about before we move on to a quick break and then really talk about some cool things afterwards is think of a story, Dave, of one of your clients that just kind of warms your heart. Like you told us about a sad one where they might call you when it's too late. You're just like, sorry, we can't help you because there's a timeline involved. Tell us a story of one of your clients. You're just like, yes, this was such a success story because they came to me, they did the right things, we did the right things, and they were able to really benefit financially.

8:51John Lee Dumas:Does one come up for you?

8:52Dave Foster:Oh, all kinds of them actually come up. There's so much opportunity for people to shape their lives the way they want. But I got to tell you, probably my favorite client of all time came to me in 2003 and it was a retired woman who was at nothing but social security to live on and she had a lot that she had paid a thousand dollars for and that lot was she was going to sell it for eleven thousand dollars amazing windfall right amazing taxable windfall and we talked her through the 1031 she was kind of wanting to explore that and at the end of the at the end of the call she said well yeah i want to do this and i said are you sure because by the time everything shelled out she was really only going to save maybe five or six hundred bucks and her response has resonated to me ever since she said yeah dave but that's my 500 bucks and I said, fair enough, let's do it.

9:59We did the 1031, caught up with her a while after that.

10:03Dave Foster:She had managed to parlay that into a small rental property that allowed her to live a good retirement supplemented with her social security. That's meeting goals.

10:13John Lee Dumas:Fire Nation, it's just one of those wins sometimes that sets you up for success after success. I mean, I've had so many clients, listeners, students of mine over the years who have just gotten one small win at one point and it just made them believe it gave them the confidence. And then they rolled that into a bigger win and a bigger win and a bigger win until they're living the exact financial and lifestyle of their dreams. So I love those stories. And again, you don't always have to look at these wins as like, Oh, it has to be like a six figure, a seven figure win. No, sometimes it can really be that, that starting, that building block that builds your foundation.

10:47John Lee Dumas:We're going to be talking about some of these cool things when we get back from thanking our

10:51Dave Foster:sponsors.

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13:18John Lee Dumas:So Dave, there are always better ways of doing things. I want to talk about your experience specifically here. What is the number one trick to a successful 1031 exchange?

13:29Dave Foster:Well, I would say that the number one trick to the exchange process itself is being focused ahead of time. you do not want to ready fire aim so even before you are thinking to sell a piece of property you should be investigating when is going to be the right time to sell this property and where am I going to put it honestly in this market the only people I see that will that typically will fail in their exchanges are those that don't know where they're going to go and are not already immersed in their next market because they've got too broad of a focus. And the 1031 exchange, although that's the downside of it, the positive side to the 1031 is that you can use it to move real estate anywhere you want in the country of any type and any nature.

14:23Dave Foster:So you can sell in California and buy in Tennessee. You can sell commercial and buy residential. The world is your oyster. And if you're not focused, though, you end up then having paralysis by analysis. And those short timeframes will catch you. So I think early focus is probably the biggest key.

14:46John Lee Dumas:So I love that. And I kind of want to keep going in this direction because we said we were going to keep things light. We're going to keep things fun. And that's kind of what I want to do with the rest of this interview right now is really talk about some other tips, some other tactics, some other strategies. and if any specific situations come up where you're like, yes, this person did it right, definitely share that as well, but really bring this process to life for Fire Nation. Sure. It's going to be specific, as you would imagine, to wherever you find yourself

15:15Dave Foster:in a real estate market. Now, anybody who says that they can time a real estate market or predict it, of course, we're going to doubt their veracity, right? But we certainly know what the general course of any real estate market is like. And it's been that way for centuries. So the 1031 exchange, the way I see people actually using this is that they will take, first of all, they'll start with an investment property. And that investment property is going to be probably in an area that's going to highly appreciate. Think about California throughout about 2010 to 2018, how much the appreciation was.

15:55Dave Foster:But generally, if you were trying to rent those properties, you weren't going to make the kind of cash flow you wanted. So people will use the 1031 exchange to sell from a highly appreciated environment to an environment where they can get more cash flow on their rentals. Or they will sell, or they will make a natural transition from, say, residential investing, where you've got to look at tenants every six months or a year, to commercial investing, where you can have a tenant for 10 to 15 years. And then they'll gradually start to shape their portfolio into what suits their needs and the type of investing that they love to do.

16:41Dave Foster:There's a whole huge population now that are beginning to 1031 exchange into vacation rental properties. They love that. And so they're selling these single family rentals or multifamily properties. And they're investing in the Smoky Mountains and California Beach and Florida. And these are all properties that qualify for 1031. One, they're properties that they can let out their inner freak flag of hosting. And they're properties they can make money from. But John, they're also properties that they can get some personal use from. So I have clients who are perpetual snowbirds. If their condo in Colorado is open, they go there for a while.

17:28Dave Foster:The rest of the year it's rented. When Colorado's full, they'll go watch the colors change in the Smokies. and that's how they're living their dream. That's the flexibility that's with you when you're doing the 1031 exchange. But that just kind of comes back to what we were talking about, that it takes planning and it takes a very strategic focus.

17:48John Lee Dumas:See, I love this because Dave, so often I get from my listeners what they want out of life. They want flexibility. They want financial freedom. They want location freedom. They just want lifestyle freedom. And it sounds like this is the kind of life you can build with these correct 1031 exchanges when you're doing it the right way. So take us home, brother. What else do you want Fire Nation to know about the tips and tricks of the 1031 exchange? What do you want Fire Nation to really walk away with from our entire conversation today? Take the stage. This is your final keynote of the conversation.

18:22John Lee Dumas:Take it home.

18:23Dave Foster:You know, I think the message that everybody needs to understand is that the IRS wants you to do this process. It's nothing that is out of the ordinary at all, what it is doing is it's encouraging investment in real estate. And the key component is that the 1031 exchange allows you to harness a form of compounding interest. And as Albert Einstein said, compound interest is the eighth wonder of the world. If you understand it, you're going to benefit from it. And it's being able to use the deferred tax dollars to benefit your investing so that you make the money off the deferred tax dollars and then you get to make the money off the money you made off the deferred tax dollars.

19:13And by the end of your life, done correctly,

19:16Dave Foster:the 1031 investor will have paid no tax on real estate sales throughout their life. And here's the absolute best benefit. I call this the four Ds of 1031 investing, John. It's defer, defer, defer. Take every advantage you can of compounding that interest and that defer tax. And then at the end, here's the biggest D. And it's not what you'd expect. It's not defer. It's die. Because when you pass away, your investments will go to your heirs at what is called a step up in basis. Your heirs get your properties as if they paid market value for them on the day you died. So by simply using 1031 exchanges, you're not owned throughout your career.