Understanding 1031 Exchanges

One of the strongest tools for minimizing a real estate investor’s tax liability is the 1031 exchange. The 1031 exchange gets its name from Section 1031 of the U.S. Internal Revenue Code, which allows investors to avoid paying capital gains taxes when they sell a property and reinvest the proceeds into a new property or properties of like kind and equal or greater value. But how do 1031 exchanges actually work? Let’s take a look.

The overwhelming majority of 1031 exchanges are delayed, three-party exchanges. Delayed exchanges require a qualified intermediary, which is a person or business who holds the cash after you sell your property and uses those funds to buy the replacement property for you.

In order to reap the rewards of a 1031 exchange, the transaction must be completed in a certain timeline:

45-Day Rule

After you’ve sold your property, your intermediary will receive the proceeds from the sale. The seller cannot personally receive the funds, or it will invalidate the 1031 exchange. The seller has 45 days from the day of the sale to designate the replacement property in writing to the intermediary, specifying the property you want to acquire. The good news is that if you’re still uncertain which property you’re purchasing next, you can buy yourself a little time by designating up to three different properties. You are only required to close on one of them.

180-Day Rule

You must close on the new property within 180 days of the sale of the previous property. It’s important to note that the 180-day period starts as soon as the first sale closes. The 45-day and the 180-day periods run concurrently. If there is any money left after the purchase of the new property, the intermediary will pay it to you at the end of the 180 days. That additional income, referred to as “boot,” will be taxed as a capital gain.

Qualified Intermediaries

As we mentioned above, a qualified intermediary sells your investment property on your behalf, buys the replacement asset, and then transfers the deed to you. The intermediary is responsible for holding the money from the sale, preparing any related legal documents, and ensuring that the transaction is completed within IRS guidelines. The exchange agreement must expressly limit the investor’s rights to receive, pledge, borrow, or otherwise obtain benefits of money or other property held by the qualified intermediary.

So who exactly are these qualified intermediaries? First, we’ll specify who the qualified intermediaries are not. You cannot act as your own intermediary, nor can you enlist a parent, sibling, or one of your children to act as your QI. In addition to family members, the IRS section 1031 bars anyone who has acted as your “agent” in the past two years from acting as your QI. The term “agent” is applied broadly, and can include your attorney, your CPA, your real estate agent, or any employees.

Apart from the above restrictions, there aren’t any licensing or educational requirements necessary to be a qualified intermediary. But since 1031 exchanges are complex transactions involving a lot of money, it’s best to seek out someone who is experienced and knowledgeable. While your CPA, attorney, or real estate agent aren’t legally able to act as your qualified intermediary, they may be able to recommend a person or company that will act as your intermediary. There are many companies that exclusively handle 1031 exchanges, and now some major banks such as Wells Fargo offer qualified intermediary services.

The cost of a 1031 exchange

The fees for 1031 exchange services vary based on the property type and value, but the cost for a straightforward delayed exchange usually ranges from about $600 to $1,000. If more than one property is involved, you might pay an extra $350 per additional property. Given the amount you’ll save in a 1031 exchange, the cost of hiring a qualified intermediary will pay for itself many times over.

Note: MC Companies does not offer 1031 exchange or qualified intermediary services.

Why We Like New Construction and Value Add

MC Companies Strategy over the last few years has been a lot of value-add deals. However, now that the market is changing, we are increasing our new construction projects. Here’s why we like both types of deals. 

New Construction

New construction has some key advantages over existing construction. The biggest one currently is that cap rates on new construction are much better than on existing buildings. This is mainly because MC companies both builds and manages our projects in house. In addition, migration patterns have sped up since the pandemic began. Notice we said sped up and not changed. Almost all of the migration we are seeing now, we were already seeing before, but it has been accelerated. This wave of migration allows us to find locations that are growing beyond their rental supply and create properties where there is a need.  

Value Add

However, we also love value-add properties. They are how we grew our company. The great part about value-add is that it offers so much opportunity. Typically, value add deals are mismanaged and the current owners need out. This can be for a variety of reasons. They may need the money, or aren’t charging enough to cover their costs. Our team has developed a knack for identifying the potential in a property. An advantage MC Companies has is that we manage our properties in-house, so we thoroughly understand rental rates. Our management team studies the numbers and looks for where the current management is missing valuable income. If you have any questions about investing or the projects we invest in, please make sure to email us. InvestorRelations@mccompanies.com

For questions about investing or a question about your investment, email us at
(480) 998-5400

What are Class A, Class B, or Class C properties

A common question we receive from our investors is what do properties marketed as Class A, Class B and Class C mean? Each property classification reflects a different risk and return. These letter grades are assigned to properties after considering a multitude of factors such as age of the property, location of the property, tenant income levels, growth prospects, appreciation, amenities, and rental income. There is no exact formula by which properties are placed into classes, but here is a breakdown of the most common classes, A, B and C:

Class A

These properties represent the highest quality buildings in their market. They are typically newer properties built within the last ten years with top amenities, high-income earning tenants and lower vacancy rates. Class A buildings are well-located in the market and are typically professionally managed. Additionally, they can demand the highest rent because of their location with little or no deferred maintenance issues.

Class B

These properties are one step down from Class A and are generally older, tend to have lower income tenants, and may or may not be professionally managed. Rental income is typically lower than Class A, and there may be some deferred maintenance issues. Mostly, these buildings are well-maintained and many investors see these as “value-add” investment opportunities because the properties can be upgraded to Class B+ or Class A through aesthetic upgrades to the units. 

Class C

Class C properties are typically more than 20 years old and located in less than desirable locations. These properties are generally in need of renovation, such as updating the building infrastructure to bring it up-to-date. As a result, Class C buildings tend to have the lowest rental rates in a market.

What does this mean for investors?

It is important for investors to understand that each class of property represents a different level of risk and reward. Class A provides investors with more security by knowing that they are investing in top tier properties, with little or no outstanding issues requiring further capital expenditures. 

Class B and C properties tend to be bought and sold at higher CAP rates than Class A, as investors are paid for taking on the additional risk of an investing in an older property with lower income tenants, or a property in a lower income neighborhood.

What is a Personal Financial Statement?

If you asked the average person “What’s your salary?” or “How much money do you make?” 99% of the population could tell you an exact dollar amount.  If you asked those same people how their overall assets compared to their liabilities, many wouldn’t have a clue. This data is crucial because it is how you come up with your actual net worth. 

Most people can tell you what their biggest expense is and how they are actively working to make it smaller. They can tell you how much money they have left on their car loan, and when they plan to pay it off. A good majority of people know their finances each month, but they don’t know their full financial situation.  

Creating a personal financial statement is a great way to get clear on your financial situation. A personal financial statement is a document or spreadsheet that outlines an individual’s financial position at a given point in time, specifically a breakdown of total assets and liabilities. The statement can help individuals track their financial goals and wealth.

A personal financial statement shows the individual’s net worth which reflects what that person has in cash if they sell all their assets and pay off all their debts. If their liabilities are greater than their assets, the financial statement indicates a negative net worth. If the individual has more assets than liabilities, they end up with a positive net worth. Keeping an updated personal financial statement allows an individual to track how their financial health improves or deteriorates over time. 

A personal financial statement is broken down into assets and liabilities. Assets include the value of securities and funds held in checking or savings accounts, retirement account balances, trading accounts, and real estate. Liabilities include any debts the individual may have including personal loans, credit cards, student loans, unpaid taxes, and mortgages. Debts that are jointly owned are also included. Married couples may create joint personal financial statements by combining their assets and liabilities.

The following items are not included in a PFS:

Business-related assets and liabilities
These are excluded unless the individual is directly and personally responsible. If you have a personal guarantee then it is included in your personal financial statement.

Rented items
Anything rented is not included in personal financial statements because the assets aren’t owned. This changes if you own the property and rent it out to someone else. In this case, the value of the property is included in your asset list.

Personal property
Personal Property is not normally included in a personal financial statement unless it is highly valued and can be priced by an appraiser.

What is an Accredited Investor?

An accredited investor is a person or entity who has been deemed capable of taking on the increased risks associated with certain investment offerings. Accredited investors have the best choices when it comes to investment options beyond exchange-listed securities. At MC Companies, we choose to work solely with accredited investors. 

What Are the Requirements?

To qualify as an accredited investor, a person must meet one of two tests:

1. Have an annual income of at least $200,000 (or $300,000 for joint income with a spouse) for the last two years with the expectation of earning the same or higher income in the current year; or

2. Have a net worth exceeding $1 million, either individually or jointly with their spouse. (The value of your primary residence can’t be included when calculating net worth)

In this segment Ken chats about his investors: ow MC Companies qualifies them, why as a company they choose to only work with accredited people, and how MC Company is different than other companies when raising money and investing. 

Click here to listen.

Why Multi-Family?

Real Estate is a great option for building equity or income generation. Unfortunately, there’s a misconception that real estate investing requires you to get hands-on with countless details every day. Very few people are aware of the passive investing opportunities in multi-family private placements or apartment syndications. These strategies are all about pooling money together with other investors to purchase large assets. A syndication structure works well because it allows you to own an apartment building for a little investment compared to what the property is actually worth. 

Why Invest? 

Multi-family real estate is a diversified asset in itself. This is largely due to the fact that when you buy an apartment building, you are investing in many units. With single-family homes, you have only one unit and one tenant. If your tenant moves out or doesn’t pay rent, you are 100% vacant and 100% unprofitable. With a 200-unit property, you could have as many as 30 vacancies and still be profitable. Also, many people invest passively in syndications because they can spread out their risk among several different properties.   

Advantages of Multi-Family

  • hands-off approach to investing in real estate 
  • tax advantages equal to or exceeding single-family 
  • recession-resistant asset class
  • There’s a nationwide demand for affordable housing 
  • You are able to leverage the expertise of your team of investors