A Deep Dive Into Real Estate Exchanging

American folklore attributes the transfer of Manhattan Island from the Native Americans to the Dutch colonists in 1626 for $24 in beads and other valuables. This is the first known Real Estate Exchange.

Since that first exchange, there has been an evolution of bartering and exchanging of real estate and other property continuously to our present time.

Let’s fast forward to our current time and explore how the exchange of real estate has evolved.

Most of our Readers are familiar with the IRS Section 1031 Exchange. The 1031 Exchange allows the investor to exchange real property that was held for investment, rental, or business use (Relinquished Property) for other real property (Replacement Property) that will also be held for investment, rental or business use. This enables you to defer the payment of your ordinary income, capital gain, and depreciation recapture income tax liabilities.

The Replacement Property must be of equal or greater value than the Relinquished Property. You must also have a mortgage on the replacement property of equal or greater than the mortgage on your relinquished property. If either of these conditions are not met, you will need to pay income tax on your gain.

You will also need to meet specific timelines. You have 45 calendar days from the day of closing on your relinquished property to identify your replacement property(s) and exactly 180 calendar days from the closing on your relinquished property to close on your replacement property.

It is important that you do not receive any funds from your relinquished property. They need to be placed in the hands of a Qualified Intermediary. You must retain the services of a Qualified Intermediary to administer your 1031 Exchange before you close on the sale or purchase of any property. The 1031 Exchange Qualified Intermediary industry has no licensing or regulatory oversite. Be sure you select one carefully that has annual audit and minimum equity capital requirements and insurance. Your title company, tax advisor or attorney may be able to introduce you a Qualified Intermediary. I recommend you get acquainted with one and ask a lot of questions before entering into a 1031 Exchange. I also recommend you consult with your tax advisor and attorney to see if a 1031 is right for you.

These are but the basics of the 1031 Exchange. There are many alternatives for the replacement properties that qualify for 1031 treatment. TICs and DSTs are but a few. There are also many nuances that your particular situation might require.

Clearly, we are entering challenging times in the real estate industry. In my opinion, there are some serious economic headwinds approaching real estate investors and brokers. We will need to find solutions to the challenges we are facing. We will need to be more creative and proactive in solving the problems of increasing capitalization rates, decreasing property income, increased lending requirements, increasing interest rates and the changing needs of the property owners. There is probably not going to be cash buyers and affordable financing to solve these problems.

However, all is not doom and gloom. We have experienced these cycles before and not only survived but thrived. “Exchanging” has come back on the scene as “Equity Marketing.” Equity Marketing is not well recognized and/ or understood by the property-owning public and most brokers, as well as related professionals such as attorneys, accountants, financial planners and lenders. Equity Marketing focuses on the client’s problem and the client’s goals and not so much on the property. Creative solutions are the key. Perhaps this could be best illustrated by an actual transaction:

A Tucson broker received a call from an investor-client in Illinois. The client owned a small dairy farm in Missouri. His tenant had stolen all the milking equipment and milk cows, sold them and left the area. The market was in the middle of a recession and land prices were down considerably. There were no cash buyers. The broker counseled his client to see what he might do to help solve the problem. The client said he might take vacation home or marina in exchange and could add some cash.

The broker was a member of the National Council of Exchangors and he took the problem to one of the quarterly conferences. When he presented the problem, a broker from Florida responded. The Florida broker had a client that was building condos in Florida and they weren’t selling. The bank was going to foreclose.

The brokers put together a transaction to present to their respective clients. Florida took the dairy farm and gave three condos. Illinois gave the dairy farm and received three condos. Illinois also added cash to balance the equities in the exchange. The builder was happy, the banker was happy, the Illinois investor was happy, as he got his vacation home and rented the other two condos until the market turned. He then sold them for a profit and had solved his dairy farm problem.

Happiest was the builder’s wife. She had horses in Florida that were running out of pasture in the summer. She trucked them to the dairy farm in the summer to pasture in Missouri. (Even the horses were happy.) The brokers were happy, because they were paid.

This kind of creativity and collaboration will be important in the down cycles.

I know of a recent Tucson multi-million-dollar industrial land transaction that involved an exchange component for part of the Seller’s equity. The balance was cash and seller financing. This transaction never would have closed without Equity Marketing. Equity Marketing is only another tool to help get us through the upcoming cycle and help provide solutions to difficult situations.

I suggest you think about how you can use the tool of Equity Marketing to solve your own real estate related challenges.

As we face our economic headwinds, keep an open mind, be creative and don’t be afraid to think outside the box. There are opportunities in down cycles. Watch for them. You probably won’t be able to leverage $24 worth of beads into Manhattan Island, but…maybe?

Tom DeSollar is the broker and owner of Arizona First Properties, LLC, a boutique real estate brokerage and consulting firm specializing in commercial, land, Industrial and multifamily properties. It serves a focused and select clientele. Tom has been in the real estate business since 1969 and is past president of the National Council of Exchangors. He holds the Equity Marketing Specialist designation. (EMS) To learn more, Tom should be reached at Tom@AZFirstProp.com.

Published in the June 2024 Issue of Tucson Real Estate + New Development.  Subscribe online at www.trendreportaz.com.