Interview with Dave Foster of The 1031 Investor

SHOW NOTES

Welcome back to the Passive Mobile Home Park Investing Podcast, hosted by Andrew Keel. In this episode of the Passive Mobile Home Park Investing Podcast our host Andrew Keel interviews Dave Foster, Founder and CEO of The 1031 Investor.

Dave Foster, a seasoned 1031 intermediary investment professional, brings over two decades of expertise in all aspects of real estate investing, ranging from commercial to residential properties. With a degree in Accounting and a Master’s in Management, Dave possesses a deep understanding of 1031 exchanges, enabling investors to strategically leverage these funds for passive investments.

In this episode, Andrew Keel and Dave Foster dive into the complexities of 1031 exchanges. They explore the advantages of these exchanges for both active and passive investors, strategies for transitioning to passive investing using 1031 funds, and forward-thinking retirement planning, including converting properties into retirement residences. Additionally, they discuss the impact of the 2018 changes on furnishings, fixtures, and equipment (FF&E), as well as the nuances of capital gains taxes and the current tax rates.

Join the conversation today as Dave Foster shares his extensive real estate investing knowledge and offers invaluable insights into the intricacies of the 1031 Exchange.

***Andrew Keel and Keel Team Real Estate Investments (Keel Team, LLC) do not endorse any interviewee. This interview is for informational purposes only and should not be depended upon for investment purposes. ***

Andrew Keel is the owner of Keel Team, LLC, a Top 100 Owner of Manufactured Housing Communities with over 3,000 lots under management. His team currently manages over 40 manufactured housing communities across more than 10 states. His expertise is in turning around under-managed manufactured housing communities by utilizing proven systems to maximize the occupancy while reducing operating costs. He specializes in bringing in homes to fill vacant lots, implementing utility bill back programs, and improving overall management and operating efficiencies, all of which significantly boost the asset value and net operating income of the communities. Check out KeelTeam.com to learn more.

Andrew has been featured on some of the Top Podcasts in the manufactured housing space, click here to listen to his most recent interviews:  https://www.keelteam.com/podcast-links. In order to successfully implement his management strategy, Andrew’s team usually moves on location during the first several months of ownership. Find out more about Andrew’s story at AndrewKeel.com.

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Talking Points:

00:21 – Welcome to the Passive Mobile Home Park Investing Podcast

01:11 – A crash course on the 1031 exchange for commercial real estate investors

08:43 – Using 1031 funds to move into passive investments

12:45 – Using 1031 funds for a (mobile home park) REIT investment.

17:00 – Planning ahead for your retirement and tips on managing the often daunting time-frame limits associated with 1031 exchanges

21:10 – Converting your 1031 exchange property into a series of retirement primary residences

23:21 – FF&E (furnishings, fixtures, and equipment), and the impact of the 2018 IRS tax law changes

26:00 – Nuances of Capital gains taxes and the current tax rate

27:34 – Getting in touch with Dave Foster of the 1031 investor

28:35 – Conclusion

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Links & Mentions from This Episode:

he 1031 Investor: https://www.the1031investor.com/

Keel Team’s official website: https://www.keelteam.com/ 

Andrew Keel’s official website: https://www.andrewkeel.com/  

Andrew Keel LinkedIn: https://www.linkedin.com/in/andrewkeel 

Andrew Keel Facebook page: https://www.facebook.com/PassiveMHPinvestingPodcast

Andrew Keel Instagram page: https://www.instagram.com/passivemhpinvesting/

Twitter: @MHPinvestors

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TRANSCRIPT

Andrew: Welcome to the Passive Mobile Home Park Investing podcast. This is your host, Andrew Keel. Today, we have a new guest in Mr. Dave Foster, founder and CEO of The 1031 Investor. 

Before we dive in, would you mind please leaving this podcast a review? It only takes about 30 seconds. This helps us get more listeners and shows me that you’re listening out there, so thank you for making my day with that review of the show. 

All right, let’s dive in. Dave Foster is a qualified, intermediary investment professional with a degree in accounting and a master’s in management. He has over 20 years of experience working in all phases of real estate investing from commercial to residential, and is inspired to help investors excel. Dave, welcome to the show.

Dave: Thanks so much, Andrew. It’s great to be here.

Andrew: Would you mind starting out by telling us a little about your story and how in the world you came to be a qualified intermediary?

Dave: One of my mentors once described it as I wanted to go two miles deep in a two-foot-wide creek. Another interpretation of that is I’m a tax nerd, but that is what it is. Qualified intermediary, that part of my life, describes the function of the unrelated third party who has to process 1031 exchanges for people. 

For those that don’t know what that is or maybe just heard about it, the 1031 exchange allows you to sell investment real estate. Then following the process, using someone like us (a qualified intermediary), you purchase new investment real estate. 

By doing so, you don’t have to pay the tax or the depreciation recapture in between. Instead, all of that deferred tax is deferred indefinitely, and you get to use it for your benefit. You’re basically getting to compound interest. You’re making the money off the money you didn’t pay in taxes, and then the money off the money off the money. It’s really quite a unique statute and an incredible opportunity for real estate investors. That’s the qualified intermediary part of my life. 

The other part is I’m just an adrenaline junkie, frustrated real estate investor, with more than a small touch of ADD. I never met a piece of real estate I didn’t like

Andrew: That’s fantastic. What are the latest legislative updates in regards to the 1031 exchange? I think it’s important to touch on that.

Dave: Oh man, so much noise. I’ve been doing this for 25 years, and every president I have ever been under, every one of them—Republican, Democrat—have all talked publicly about getting rid of the 1031 exchange, because it’s low-hanging fruit. One thing that we’ve seen in this current administration is that they’ve taken it to a new level. Every year, they take it out in their next budget. 

But what happens is there’s this amazing set of statistics that are true, that once they get rolled out every year, getting rid of 1031 goes away. Here’s what happens. 

They’re shown by some studies—the latest one that’s been around out there by Ernst and Young—that for every dollar that you would get by eliminating the 1031 exchange, and in capital gains tax, which, remember is a lower tax rate, you’re going to stifle the real estate industry. Because why? If I’ve got to pay tax, why would I sell? So I’m going to slow down the velocity of my real estate investing. 

There are going to be fewer sales, and every time there are fewer sales, the government loses out on the ordinary income tax of two realtors, two title companies, two appraisers, two inspectors, two real estate attorneys, two accountants to an extra filing form, two painters getting the properties ready. 

When you start to add that up, well, first of all, that’s an amazing amount of money that’s coming out of normal people’s salaries. That doesn’t play well with a congress who’s concerned about getting votes. They don’t want to be the one that puts mister painter out of business.

Andrew: It’s like right now. The opposite effect is, hey, you just raise rates, and then transactions come to a 10-, 20-year halt.

Dave: We’ve seen it, haven’t we? 

Andrew: Yeah. 

Dave: They see that and feel that pain a lot. The other thing is that in real dollars, they actually lose several billion dollars in transaction velocity and tax from that for the sake of what they get. This is another crazy stand, Andrew, that nobody knows because the current administration loves to throw it around, that 1031 exchanges are for the rich guys. It’s all these rich fat cats doing it, when in fact, the average size of a 1031 exchange is less than $400,000. So, tell me, is that the fat cats or has the current administration trying to take away a tool that normal America uses?

Andrew: I think this is important to touch on this too, Dave. I’ve been lucky enough to travel a little bit into Europe. I just remember being over there and seeing these generationally-owned properties. They are just dilapidated because there’s no real reset with a new owner to reinvest into these things. I wonder, is there something similar to the 1031 overseas? Or is this a US specialty?

Dave: It’s actually a US phenomenon. Your observations are absolutely right. This does not exist in Canada, does not exist in Europe. Here’s why; this is a crazy history. 

Section 1031 was put into the tax code in 1920. It’s been there for a long, long time. The reason was that during that period, we were coming out of World War I, we desperately needed to grow our agribusiness industry. We were a hungry nation. 

We were coming out of the homestead era where every farmer had 160 acres. But how could they grow? The only way they could buy more farms was to sell their farm. If they did that and paid the tax, they wouldn’t have any money to buy the new farm. So they couldn’t grow. But even more importantly, what about all the young kids and future farmers of America wanting to become farmers? If I don’t sell my small farm, I can’t. How can they get in? Section 1031 was put into place to allow those farmers to keep the tax, to grow their farms. What a great way to stimulate that. 

Over the years that’s been expanded. The attorney’s got a hold of it and all kinds of stuff, and now it’s available for us. We see what it does in the real estate industry, don’t we? Now there’s motivation. When it’s time for me to change classes, buy bigger, go smaller, go from active to passive, I can do that without fear of this huge tax bill following me.

Andrew: Let’s touch on that. You mentioned going from active to passive, and how one could use 1031 funds to move to the passive realm. Would you mind describing that for us?

Dave: Absolutely. First of all, though, let me just give a ray of hope, because we just did it on a real downer note. 1031’s going away. Every year when this happens, cooler heads prevail and section 1031 is left untouched. 

The last time around, we’ve got the Congress and Senate fighting each other. The Senate voted unanimously that 1031 could not be touched. So I’m not too worried about it. Even in the current plans, they’re looking at limiting it to a million dollars per gain a year. I don’t see that having a huge impact on middle America. I think we’re okay with that. 

Now, you’re absolutely right. Let’s talk about that passive thing, because one of the cool features about the 1031 exchange is that it will not only allow you to change into any class of real estate you want. You can sell single family, buy multifamily, commercial to mobile home parks, anywhere in the country. Selling in California and buying in Texas, selling in New York, buying in Florida. It’s all considered the same as long as it’s investment real estate. 

But it does have to be real estate. Many of the syndications or limited partnership passive opportunities that we see these days, are structured so that there is an entity, whether it’s an LLC or a limited partnership, that owns the subject real estate. 

Andrew: You’re investing in an LLC, right? In a business, not the real estate.

Dave: That’s exactly right. It doesn’t qualify for a 1031 exchange. I literally get these calls every week—how can I make this happen? Well, first of all, if it’s the right time, and if the wherewithal in your lifecycle is telling you that active management’s done, I no longer want toilets and tenants, then sell your property, pay the tax.

If you want to put a small amount into it—because a lot of people will test the waters with syndications—do a 1031 exchange. Sell your property and pull a small amount out, because you can purchase less than you sell. You can take cash out in a 1031 exchange. You’ll only pay tax on what you pull out. Then post-tax, you can go into your syndication, and that can work.

Opportunity number three is that there are syndications out there—not very many, but there are some—where they have been set up so that you can actually 1031 exchange. Instead of a percentage membership of the entity, they sell to you a tenant in common interest in the actual underlying real estate. That can be a great way to get in and do it. 

Two problems with that. There’s not very many that do it because it’s complex and it takes a lot of paperwork on their end to make it work. Which then secondly means generally they will require a very substantial investment in order to do that for you. Like they might say, well, yeah, if you’ve got a million dollars to put into my project, we’ll take you as a tenant in common. Those are all ways that can work.

Andrew: And we did that once, with a family friend that wanted to put in a million dollars, and we wouldn’t do it again.

Dave: It was a nightmare, wasn’t it?

Andrew: For the paperwork that had to be involved. And you don’t think about the tax consequences and all of that kind of stuff in addition to the paperwork. There are some hurdles there. But I was wondering, could someone invest in a REIT with 1031 funds?

Dave: Actually, the exact same thing. The REIT is a business entity in itself. When you buy the REIT, you’re not buying real estate. Now there are ways to convert real estate into a REIT without paying taxes (initially) through what’s called a 721 (UPREIT). That will work. 

But here’s the problem with that, Andrew. This is going to lead us right into my last and best option. The problem with that is that once you go down that road, your compounding is done. When you sell the REIT, you’re paying tax. You’re paying all the tax, and you can’t 1031 back out of it. 

For that reason in my life and in so many of my clients’ lives, we always take great care to keep securities, which are investments in entities, and real estate investment, which is investment in bricks and mortar, separate. Because I can’t 1031 across and come back. If I do it once, I’m done. I’m going to pay the tax sooner or later. 

That’s not cool because with the 1031, there is an option to defer it throughout your entire life. And when you die, your heirs will inherit that property tax-free. Plus you get all the depreciation, all of the other components of the internal rate of return, amortization of the loan, appreciation of the property. You don’t always get all of that with an entity. You’re limited to what they’re willing to provide you. 

Here’s how we’ve bridged that gap, and it’s really a slick way of doing it. The 1031 exchange (again, like we said) requires that you purchase at least as much as you sell. Let’s say someone was selling a $500,000 property with $200,000 in a loan. They have $300,000 of cash that goes into their exchange account, and they have to purchase $500,000 of real estate. With me so far?

Andrew: Yup.

Dave: What if instead of buying a property for $500,000, they took advantage of the flexibility of the 1031 and they bought two properties? The first property they buy for $250,000 cash. Well, automatically that just sets itself on the side. No muss, no fuss. It’s recession-proof because it doesn’t have debt. You’ve lessened your risk, you’ve concentrated the equity, but you still have to purchase another $250,000 of real estate. 

With the other $50,000 of cash, you go buy another $250,000 property using the $50,000 as a 20% down payment. Now on that property, you were able to reach your $500,000 target. You have a property that you’re generating increased internal rate of return returns because you’ve now got amortization of a loan. You got the tax write-off of the interest. The tenant is paying the mortgage. We all know those are the things that boost the IRR to the moon. That’s a beautiful way to combine with loan-free real estate. 

Then my clients that want to go into passive will turn right around immediately, and they will do a cash out refinance of the debt-free property. The equity’s concentrated so they can actually get a nice chunk of it. It didn’t have a loan on it to begin with. It’s not like they’re wasting the loan origination fees the first time around, and they’ll take that $200,000 or whatever it is that they want. They will go and they will invest that into syndication because cash out refinance is not a taxable event. 

Again now, you get the exact same components of the amortization of the loan, the interest rate write-off, the tenant paying the mortgage, the huge internal rate of return, but that money’s also working for you twice. Because now, it’s invested in the syndication generating the returns on that as well. That’s as close as I could get to cooking with gasoline, and we’re seeing clients do pretty well with it.

Andrew: That’s an interesting strategy. They’re definitely levering up and going for it. Thank you for sharing that with us. Let’s talk about real quickly, if you don’t mind, what don’t we know about the 1031? What’s not talked about enough in regards to the 1031 that you think most investors should be aware of?

Dave: What’s in there in 10,000 pages of case law that, how much time do we have? The timeframes are what scare people the most. That’s really far and away the greatest fear factor in doing a 1031. That is the first one. I don’t want to do that because I only have 45 days to identify my replacement property and 180 days to close. 

Well, I’m kind of like the Pollyanna man. You show me a problem and I’ll look at it as an opportunity. Show me a problem to fix. I’ll find a way. The 45 days, is it tight? Sure. But what if you thought about your 1031 before you sell your property? Start planning ahead of time. We do internal audits all the time. Over 95% of our clients complete their 1031 exchanges. And this is going all the way through that really tough time when nobody could find properties to buy. Ninety-five percent are still making it happen. 

The fear is a lot more perceptual than real. But let’s back that up. If you’re scared of not having 45 days, you can go into contract for your new property before your old property closes. Why not? 

As soon as you get a contract for your old property, get your new property under contract. Be far enough along in the process that you feel comfortable doing that using a contingency, or even being far enough along in your sale that you feel comfortable with it happening. That’s an instant way to stretch out that 45 days to make something manageable.

That’s a hack that a lot of people don’t know. Then the 180 day period, usually that’s not so much of a problem. But there is a very strong trend in 1031 investing to do what I call capital expense avoidance. Because it was all I could afford. So I bought a 1927 duplex that’s blocked construction and everything’s rusted, and it’s got a new roof that it’s going to need. Well, one roof will wipe out 20 years of cash flow. If I’m hanging onto that, I’m hanging onto a house of cards. 

So why not go into contract with a builder who’s going to be building a house that isn’t going to be done for 18 months? You go into contract, which again is fine. Then when he calls you up and says, hey, we’re two months out from this property being done. Put your old property up for sale. It closes (say) in 30 or 60 days, and then you immediately close on the purchase of your new property. 

You went from high capital expense risk to low capital expense risk. You had no risk of the 45-day period because you already had your property lined up. Most importantly, because you closed your sale and you closed your purchase close together, you have less time out of service. So you’re restarting your cash flow much quicker. The 45 days is a big one. 

Your folks are all going to quit watching right after we talk about this, because this is the cherry on top. What 99% of people do not know is that you can eventually start to convert your 1031 properties with massive deferred taxes into a series of retirement primary residences. When you do that, you will then start to transition deferred tax to tax-free for every year that you live in it.

Here’s a real example of that. I’ve got a client in St. Pete Beach who used a 1031 and bought three identical condos on the same floor in a building on St. Pete Beach. He used them for two years for investment and then he moved into the first one. Once he had owned it for five years—that meant that he used it for investment for two, had rented it for three so he owned it for five—he sold it. He was able to take 60% of the gain tax-free, and only recapture depreciation. Where do you think he moved, Andrew?

Andrew: Into unit number two.

Dave: Absolutely. That’s his retirement plan. No delivering Domino’s Pizzas. No bagging groceries. His retirement plan is, yeah, Dave, I pay a little bit of tax because I only get prorated, but I’m also getting a huge chunk of tax-free dollars every so often. 

People who are doing that to relocate for retirement, like you’re selling your portfolio in Cincinnati, you want to retire in Sarasota, it’s when you sell your house in Cincinnati, if you’re married, the first $500,000 that’s tax free. Or why would you invest in a new house?

Andrew: Let’s circle back real quick. I love that strategy. Before we started recording about FF&E and how mobile home parks have this really unique aspect where the mobile homes are personal property and the land itself with the improvements and so forth, would you mind touching on that? I think that would be good for our listeners to hear.

Dave: Absolutely. In its original form until 2018, 1031 allowed you to sell real estate and invest in real estate, and personal property and invest in similar personal property. We exchanged jet planes, heavy equipment, restaurant equipment, mobile home park equipment for other mobile home park equipment. In 2018 that was eliminated. 

FF&E stands for furnishings, fixtures, and equipment. It’s all of this stuff at a mobile home park that’s not real estate, and you can’t exchange that. When you’re looking to buy a mobile home park, or when you’re looking to sell one and do a 1031 exchange, you want to make sure you’re working with your accounting professionals to try and minimize your FF&E number as much as you can, because you’re going to have to pay tax on that. And get as much of it allocated into real estate as possible because then you could go and purchase any type of real estate you want.

Andrew: The downside for the buyer is that their property taxes are probably going to go up because they have more allocated to real estate. It’s a fine line there.

Dave: That’s exactly right. It’s a dance. It ends up being whose lawyer is tougher.

Andrew: Who knows about the 2018 rule change? That’s important.

Dave: Now, the nice thing with mobile home parks is that when we’re seeing the purchase now, if you’re in one of those where you own the units and those convey with the lots that they’re on, the actual unit is considered to be real estate as well. Generally, there’s very little non-real estate component—a couple of golf carts, whatever.

Andrew: It would be the mobile homes if it’s like there are a lot of park-owned homes that you’re buying and you’re allocating a big value to those…

Dave: And those count as real estate.

Andrew: Well if the park owner owns the mobile homes, that would be where you’re running into this.

Dave: Those are the things to look at when you’re doing mobile home parks. Absolutely.

Andrew: Good to know. Let’s talk about capital gains taxes. I’ve seen Biden’s plan where they can go up to 44% or something like that. Let’s scare people here with what the plans are moving forward for capital gains taxes and the tax rate.

Dave: There’s so much discussion going on there. I simply look back over history to comfort myself. I don’t think we’ll see both an elimination of 1031 and a change in capital gains. That would be the whammy that I’ll be bagging groceries right next to you if that happens, of course. 

Over the last 60 or 70 years has capital gains or isn’t it capped lower? Sure. But it’s always stayed within a fairly tight range, and it always reverts. My son’s an economics major. Not me; I haven’t really studied it. But I sense that there is a reason why that capital gains range over history has stayed fairly consistent. 

With this administration might be popping up, they could. They could try, certainly. I don’t think it’s going to go massively huge. Even if it does, I think we’ll still have 1031 to rely on. I’m really not all that concerned with it. But yeah, I’d rather it didn’t, of course.

Andrew: Of course, yeah. Dave, thank you so much for all this information. If any of our listeners would like to get a hold of you, what would be the best way for them to do so?

Dave: Really simple. We created an educational website. It’s got a YouTube channel with about 50 videos on all kinds of things like what we talked about today. Calculators, articles, access to my book. It’s at the1031investor.com.

Andrew: Awesome. We should mention you have an Amazon best-selling book. What was the name of that, Dave?

Dave: It’s called Lifetime Tax-Free Wealth—how’s that for a sexy title—The Real Estate Investors Guide to the 1031 Exchange. Whatever juice I got from that first phrase, I put everybody to sleep with the second phrase. But it really is about all things 1031, and more how to use them rather than just the dry nuts and bolts. We’ve got some great case studies for clients who have been successful using it their way, and that’s always fun to watch.

Andrew: Very cool. Well, thank you so much for coming on the show, Dave.

Dave: My pleasure.

Andrew: That’s it for today, folks. Reminder, please leave us a review if you got value out of this show. Thank you so much for tuning in.