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Ten Biggest Mistakes 1031 Exchange Investors Make

By Jeffrey Bangerter

A 1031 Exchange can be confusing and stressful leading many 1031 exchange investors to make critical mistakes.

MISTAKE #1: Not incorporating IRS 1031 Exchange Qualifying Required Language in both the contract to sell your relinquished property(ies) and the contract to purchase your replacement property(ies).

If this specific IRS-required language is not in both the contract to sell your relinquished property and the contract to purchase your replacement properties, the IRS could disallow your exchange eliminating your tax benefits entirely.

SOLUTION: If you have already signed an agreement to sell your relinquished property and the language is not in the contract or you are unsure if the language in the contract is correct, you may still be able to save the exchange if specific steps are taken. Bangerter Financial Services can help you in this process. We are happy to discuss this with you and provide guidance on how to proceed.

MISTAKE #2: Taking Constructive Receipt of the Proceeds from the Sale of Your Property.

You cannot take constructive receipt of the funds from the sale of your relinquished property even if the funds go into and remain in an escrow account. A qualified intermediary (QI) must take constructive receipt of the funds from the sale of your relinquished property or the IRS can disallow the tax benefits of your exchange.

SOLUTION: If you have not engaged a QI, please contact us and we will refer you to QI’s who are experienced and maintain a large bond in favor of their clients.

MISTAKE #3: Failure to understand the difference between return ON capital and return OF capital.

Many investors buy a property because it has a higher cap rate or projected annual income than another property but fail to understand the increased risk to their invested capital a higher yield could create.

SOLUTION: When calculating return ON capital, both the annual income and the increase or decrease in value of the property upon disposition must be considered. Bangerter Financial Services will always help you make informed decisions about risk and return and provide a wide variety of institutional quality replacement properties for your review.

MISTAKE #4: Buying a less desirable property because the purchase price of the replacement property covers the full amount of the proceeds from the sale of the relinquished property.

When the cost of the replacement property(ies) does not equal the proceeds from the sale of your relinquished property(ies), the difference is considered “boot.” Boot is any cash left over after buying your replacement property. You must pay tax on any “boot.” Like many in a 1031 exchange, you may realize it is very difficult to find a replacement property with the exact price equal to or greater than the proceeds of the relinquished property. In this case, you may be tempted to acquire a less desirable property to avoid “boot.” You may also find a desirable replacement property, but to purchase the property you may be required to put in more cash or take on debt, both of which may be undesirable to you.

SOLUTION: Fortunately, Bangerter Financial Services offers many potential solutions, like DSTs, that can save you the time and effort of obtaining and guaranteeing a loan, putting in more capital, or paying taxes on the boot.

MISTAKE #5: Assuming you must apply for and guarantee a loan to replace any debt remaining from the sale of your relinquished property.

Many of our clients believed that the only way to defer the taxes on debt remaining on the relinquished property was to apply for and guarantee a loan on the new (replacement) property(ies). This process can be time consuming, and, in the end, the loan can be declined putting the whole exchange in jeopardy. Or, the lender may not complete the process in a timely manner causing you to lose out on a desirable replacement property.

SOLUTION: Bangerter offers institutional-quality real estate investments with pre-approved debt already built into the investment. This means you do not have to apply for or guarantee a loan. And because the loan is already in place, there is no chance the lender will withdraw the commitment at the last-minute, jeopardizing the entire exchange.

MISTAKE #6: Not having a strategy to identify enough alternative replacement properties should one or more of your identified properties not meet due diligence requirements or fall through for other reasons.

Once the 45-day identification period passes, you cannot add more properties to your list of target properties.

SOLUTION: Bangerter Financial Services employs several strategies to potentially help reduce the risk that your exchange will fail because the properties you thought you would acquire turn out not to meet due diligence requirements or because a loan commitment fails to materialize on time. While these strategies are not a guarantee that a problem won’t occur, they will help reduce the chances substantially.

MISTAKE #7: Mistakenly thinking you have 180 days to close on your replacement property.

What most people do not realize is that the 180-day rule does not always apply. Many 1031 exchange participants, when planning the timing of the sale of their relinquished property, incorrectly assume they have 180 days to close on their replacement property. This is not always the case.

SOLUTION: Contact Bangerter Financial Services. There are several important questions that must be addressed to ensure you don’t make a mistake by assuming you have 180 days to close on your replacement property.

MISTAKE #8: Not having enough liquidity.

We have seen a property or properties sold to people in a 1031 exchange that used up all their exchange funds from the sale of the relinquished property without doing a thorough analysis of the individual’s outside income, assets, and liquidity needs. The property then experiences some vacancy, rent income declines as a result, and the individual is either not able to make a loan payment or income they were counting on dries up and puts them in a bad position financially.

SOLUTION: Because we have securities licenses as well as a real estate license, we are held to a higher standard of fiduciary responsibility than if we had a real estate license alone. This means we are required to do a thorough review to determine the suitability of all recommendations we make to you. We must be reasonably certain you have enough outside liquidity to meet your expenses should your real estate investment not perform as planned.

MISTAKE #9: Not Diversifying Your 1031 Exchange Proceeds.

We see it happen all too often: someone is sold on a single-tenant investment based on the strength of the tenant, the management-free nature of single tenant properties, and the rent increases in the option periods. Based on this information, the investor places the entire proceeds from the sale of their relinquished property into one replacement property. In some cases, they take out a loan as well to acquire this “quality” asset. Then the unthinkable happens. What the investor thought was a safe investment turns out not to be so safe after all. Indeed, companies merge, go bankrupt, or decide not to exercise the option to renew the rent. Or, they do not agree to the rent increases in the option period and the investor does not get that nice rent increase that was expected, reducing the anticipated income and the resale value of the property.

SOLUTION: All investments have risk. Real estate is no exception for all the reasons outlined above. However, you can potentially mitigate these risks through diversification. You would be ill-advised to invest all your money into one or two stocks. We feel the same way about investing your 1031 exchange proceeds in one piece of real estate. While there are no guarantees and you could lose money, by diversifying your proceeds you potentially reduce the risks to your capital and your income stream.

MISTAKE #10: Not Using a Specialist to Advise and Represent You in the Acquisition of Your Replacement Properties.

You have a great deal of money at stake in this process. Using a specialist is a safeguard you can employ to help protect your capital and future income potential. The marketplace for commercial real estate changes daily. If your representative is not following the changes in pricing as well as property and geographic trends daily, you are at a disadvantage. As a result, you may well overpay for a property, invest in a property with less favorable long-term prospects or worse, invest in a property that has a higher-risk profile than you think. Indeed, there are many new offerings coming out every day that, in our opinion, are subpar. Our practice is devoted to finding replacement properties for clients in a 1031 exchange. Many of these clients are selling agricultural properties and investing in commercial real estate for the first time. Many are selling management-intensive properties and looking for management-free properties. As professionals, we do not list or lease real estate. Listing and leasing are very different activities and require very different daily activities, networks, and skills. In addition, most registered representatives or registered investment advisors who sell DSTs and/or TICs do not specialize in the acquisition of 1031 exchange replacement properties.

SOLUTION: Consider working with Bangerter Financial Services. Underwriting real estate deals is part art and part science, and experience matters. We developed a proprietary due diligence process based on these years of experience. We are happy to share our due diligence process with you and/or your advisors on request. The process of evaluating and closing on replacement properties on a timely basis requires full-time attention. A lot of things can go wrong. We follow a detailed critical path process to reduce the risk that something could go wrong.

How can you potentially avoid these costly mistakes?

Before working with Bangerter Financial Services, our clients felt overwhelmed with the investment options and steps that must be taken to complete a 1031 exchange. A phone conversation to answer your questions is the next step.

Bangerter Financial Services can’t guarantee that you could not lose money, but we believe sticking with proven sponsors, our rigorous due diligence process, diversification, ensuring investments meet your suitability and liquidity requirements combined with Bangerter Financial Services’ 30 plus years of experience will help increase the likelihood you will be confident with the investments made through us.

When you meet with Bangerter Financial Services, we will start by getting the answers to two very important questions. With these answers, we can determine if Bangerter Financial Services is a good fit for you and vice versa, determine if it is appropriate to meet.

Bangerter Financial Services looks forward to helping you through a successful 1031 exchange.



Topics: Retirement COVID-19 Financial Planning