Updated: Jul 4, 2020
You can 1031 into a syndication! Learn how we accomplish this challenge today on the Passive Cash Flow Show! The Passive Cash Flow Podcast is for beginner or experienced investors. Learn how you can diversify out of the stock market, own a part of an apartment building & start earning Passive Cash Flow! Peoples Capital Group has been helping passive investors build wealth in NJ real estate for 10 years. Visit www.PeoplesCapitalGroup.com to find out if you qualify to start earning passive income and pay less taxes via investing in real estate. IRA's and 401K's are accepted. -- https://www.facebook.com/peoplescapitalgroupnj/
Aaron Fragnito: All right. Ladies and gentlemen, welcome back to the Passive Cash Flow Show. This is episode number 17. We're going to talk today about how to 1031 into a syndicate. We're going to focus on a lot of investors who come to me, they say I have a building. I want to sell the building. I want to avoid capital gains tax, and I want to trade into a building with you where I don't have to do the work, and I don't have to personally guarantee the mortgage, or find the opportunity. I want a nice passive cash flow check in the mail. I want my tax benefits, and I want a big sum upon refinance. That sounds good. We try to do that for our investors all the time but 1031 complicate things. A 1031 tax deference when you sell a property and you trade into a bigger property, or a similar like size property of a similar kind, you have about 90 days to pick the property, and about 180 days to close on it after you select the property. It's a bit of a juggling act to do a 1031. You have to use a third-party 1031 company that's going to hold the funds from the sale. If you own a million-dollar building, you sell it for a million dollars, and you owe, say, half a million dollar on the mortgage, you're going to have half a million dollars from the sale. Now that can all be profit, and that's fine. The whole idea is to avoid capital gains on that profit. So you would hire a 1031 tax deference company, put it with the 1031 tax deference company, have 90 days to select a similar or like property, ideally a bigger property, and then have 180 days to close on that property. The money has to stay with the third party while you're selecting and closing on the property, and then the money is used to, of course, close on the property. Now the complication comes in with, well, Aaron, why don't we just start an LLC, and we'll add you, you and Seth as members. Investor will own 70%, Seth and I will own 30%. We'll do our magic. We'll reposition the building and work to get them past the cash flow checks. The problem is, if IRS finds out about that, basically it's skirting the rules. It's against the rules. When you do a 1031, you can't just add people to the LLC, or take people off the LLC, because they're going to get hit with taxes. It's going to disqualify the property from qualifying as a 1031. Basically, it's a big challenge to 1031 the property into a syndicate. You can 1031 the property into an LLC you already own, but you can't add people or take people off the company, the LLC, as you 1031 into a bigger building. It does complicate things for other investors that want to exit an investment, or investors that want to bring in operators like Seth and I to make the next building an easier opportunity for them so they don't have to manage it and deal with the headaches, and ideally make better cash flow because we're professionals and very experienced to what we do here. Actually there's two solutions to how to 1031 your property into a syndicate. Syndicate is a passive investment that it pulls capital together, and is operated by a general partner. One or two general partners generally. In this case, Seth and I are the general partners. We operate the syndicate in the passive investors, the limited partners bring in the capital. Normally, we just structure an LLC, and the investors get their share, and that's a nice clean way to structure syndication. In this case, we can't do that if you're 1031-ing into a property. You can't just add Seth and I to the LLC, or add five other investors that bring in money. That would break the rules of the 1031, and cause it to not qualify properly for that, and then the owner would have to pay taxes on the gains. The whole idea is to avoid those taxes, which can be huge in a real estate sale, especially over time with commercial real estate. I think the best solution is a Delaware statutory trust, also known as a Delaware State Trust. We'll call that a DST. Delaware State Trust here, that is simply a state trust that can have operators in it, general partners, and people who are passive as well, but it's pretty in depth here. It's an unincorporated association recognizing entity separate from its owners. It's formed by executing a Delaware State Trust agreement, and filing a certificate of trust with the Delaware Department of State, and Development Division of Corporations. Basically, DSTs are an alternative group of investments structure that includes trustees and management, like Seth and I, and beneficiaries, investors. The individuals selling their properties using a 1031 tax deference and trading into a Delaware State Trust that ideally, Seth and I would create. Let's say we had three or four investors, or even one big investor doing a 1031 tax deference, they can become other investors, beneficiaries in this trust. Seth and I would be the trustees. The management and the investors would be the beneficiaries. Now, if you're doing multiple investors, multiple 1031, that would be a bit of a juggling act, because they would have to sell their properties right around the same time, and have that capital available to put into the state trust right around the same time, and we'd have 90 days to identify the property, 180 days to close on it. As long as everyone sold their properties around the same time, we're able to move the capital properly into the trust, then it could be done. Then that's something we're actually lining up possibly for 2020 or 2021 here, because we have a lot of investors, about four or five investors right now that really want to do a 1031. They have a nice piece of real estate, they own a lot of equity in it, and if they sell the building, they're going to get hit pretty hard on taxes. By creating this Delaware State Trust, we create an avenue for these investors who have done their job well. They bought real estate. They created equity in it. Maybe they managed it well. Maybe they bought in the right area. Maybe they're a little bit of both, and over time, now they have a lot of equity. They want to harvest that equity and move into a bigger building but not deal with the headaches of continuing to manage the property or find a great deal. Maybe they're towards the retirement age, and it's a great opportunity for them to avoid capital gains tax on a huge gain because you could be gaining millions of dollars in commercial real estate sale. Also, not only avoid that tax, but then get into a passive investment where they can take all their proceeds, all their cash invested in that asset, harvest that assets, sell the asset through 1031 tax deference trade into a Delaware State Trust and not pay tax on that money gained. Now have a passive investment into a bigger building where they can start collecting bigger cash flow checks on that capital. Some more details about how Delaware State Trust works. It is very restrictive. They specifically disallow the trustees to engage in certain activities that are critical to most income-producing real estate. Some of these activities are negotiating new refinance loans or existing leases. Obviously, Seth and I need the ability to negotiate leases and loans. No new equity investments can be accepted even from existing beneficiaries once the offering is closed. General syndicates are different than that. They're a little easier to work with. Investors are truly passive. The beneficiaries are truly passive. They actually can't have a say in how the property's operated which normally is how our syndicates do work. Seth and I are the operators, and the investors are passive and non-voting members. The trustee can only perform normal repairs and maintenance minor non-structural capital improvements. That works for us because we try to buy buildings like that anyway; lipstick on a pig type of repairs, not big structural improvements. The property trusts must be held for investment purposes only, not for active conduct of a business; hence, the popularity of the DSTs for triple net property ownership. Now to get around all this, there are some rules, and as long as you work with the right attorneys which we're discussing right now these transactions with that's where I'm getting these notes from, you basically have a depositor. Depositor would be Seth and I, the operators, and we get the property under contract, and we sign the contract to a Delaware State Trust. The depositor keeps a portion of the Delaware State Trust interest as Seth and I normally do in syndications. That's how we pay ourselves through ownership of the business. We make sure that the property performs well so we can get paid, of course, and the portion of that Delaware State Trust interests for itself and sells the rest of the beneficiaries. Ideally, we'll own a part of the Delaware State Trust, say 30%. The other 70% is sold to the beneficiaries who are doing a 1031 and bringing that capital into the Delaware State Trust, and now they're going to get a beneficiary ownership share of that trust. Each beneficiary acquires an undivided fractional interest of the trust. Each Delaware State Trust has the signatory trustee, manager of the trust. Ideally, Seth and I be one of those as well, and to Delaware's trustee. The depositor and the signatory trustee are both 100% owned by the sponsor of the deal. The sponsor of the deal, again, the operators, in one way or another. The Delaware State Trust holds title on its own, although are wholly-owned subsidiary entity. The Delaware State Trust beneficiaries have the same limitation on personal liability, as do shareholders in a Delaware Corporation. Because of this, they can take title to their beneficiary interest individually, and are treated as if they owned undivided interest in the underlying real estate for federal tax purposes. They get tax advantages from this investment as well. The Delaware State Trust typically have a master lease agreement with a third-party lessee so that the master lessee can negotiate leases, and operate the building as Seth and I need to properly execute our repositioning of these apartment buildings, and make great returns to our investors. By working with these additional rules here, Seth and I can do the operations we need to do on our building so that we create those returns we've historically created for our investors so that they can get those passive cash flow checks and tax benefits, and big cash out revised. The more Seth and I are free to do our business activities that we're so experienced in doing and practiced in doing that, we would be able to execute properly with ease on the building, and make those returns consistently for our passive investors. The structure may include a spring LLC with a pre-written operating agreement with the trustees can invoke or confer the Delaware State Trust to an LLC if the property is in danger of being lost due to the Delaware State Trust limitation. It sounds like if there's a big issue going on, and for whatever reason, a lot of moving pieces, one mistake is made you can actually convert it to an LLC. Doing this will allow additional funds to be raised, will attract better financing, or negotiate new leases. It's one of those scenarios where it's like, yes, you can't do all these things, but if you check off this box you can do all these things. It's a classic law, right? Very complicated. You need to hire some expensive attorneys to really understand it. I basically just read to you a bunch of things you can't do, and then explained to you how you can do them, which is pretty much how most laws work in America. So if you have the right attorney, you can develop a Delaware State Trust, you can properly structure a trust where the individuals can sell their property through a 1031 tax deference, and you can put together a pool of investors that are 1031-ing their properties. It will be a bit of a juggling act, and this is something we're going to try to accomplish later this year as we line up those 1031 investors, and make sure everyone's ready to sell their property right around the same time but, of course, as you know, buyers are liars. There could be some issues there. You have a closing lined up. The buyers aren't cooperating, whatever. Are we going to wait for that individual or are we not? How long is it going to take for him to sell? Will he make the 180-day cut? A little more complicated than your average syndication but definitely an opportunity to please our investors who are looking to move this capital into the Peoples Capital Group. Definitely, a way for us to challenge ourselves as operators and learn something new, and now work with the right high profile attorneys that do this. They're not cheap, but they know what they're doing, and like any smart business owner, Seth and I, when we are working on a new idea or a new opportunity, we work with the right professionals to guide us through it. Whether that's an attorney, or a home-inspector, or an accountant, or whatever, as a realtor. There's a lot of banker. There's a lot of people we work that guide us through these different parts of our business to make sure we don't break any rules, and we do it the best, most painless, or easiest way to get things done and not over complicate things. Make it easy for our investors, but most of all, make sure we don't break any rules, because our job is to make sure we don't break any rules, that we're bringing you a nice product that's properly done, properly created, professionally managed, and overall, a nice turnkey opportunity to put your money to work where it might not be making the returns that you need to be satisfied. Here at Peoples Capital Group, we're going to start doing this for our investors. If you want to learn more about how you can 1031 your property into a Delaware State Trust with us, go to peoplescapitalgroup.com, put in your information, and we'll get in touch with you and talk to you more about how we can do this. We can schedule a call if you're qualified to invest. There's also one more way to 1031 your property into a syndicate. It's not as suggested because there's more limitations, this is called a Tenant In Common, TIC; Tenant In Common ownership. This is unique. The challenges here is that the other investors are going to all have a voting share. In addition to traditional syndicate documents, the operating agreement, subscription agreement, you need additional legal documents between the tenants for a tenant in common agreement, and an asset management agreement as well which will require extra legal fees. You will have to find a lender willing to lend to a tenant in common. It looks like it's a little easier to get loans for a Delaware State Trust. We're now talking to banks. We're talking to attorneys, and trying to develop those relationships with the right banks so we can develop a loan, because when we buy a property, we leverage our investors' capital by getting a mortgage. We're going to get a 50% loan on the Delaware State Trust. That's about the max you can do, where again, that's another downside you can't really get a 70% loan, which we try to get 70% loan value on our other properties. The larger the loan amount, the more you cash load, because the more the money is leveraged. It's actually better for our investors that we get a 70% loan value than 50%, but depending on the deal, how good it is, and how it's structured, we can still likely structure it so our investors get similar returns to our other syndications where we get a 70% LTV. In this case, we get a 50% loaned value, and that's okay, that still allows us to leverage our investors' capital by 50% but we're 100% run. Basically, the challenge with this is that the big downside to a tenant in common is that any investor splits you receive can only be derived from the syndicate-owned portion of the property. Although, you still might be able to collect reasonable asset management fee from the tenants as the ownership, but it complicates things in our end. For example, the 1031 investor exchange in your deal for 50% in the equity, and the syndicate kept the other 50%, the syndicator can only earn fees and distributions generated from the 50% of the property owned by the syndicate. That's generally how we do it anyway, but we basically don't really charge fees either. There's more flexibility with the Delaware State Trust so we're looking more into that. We're leaning in towards that. The tenant in common is one way to do it as well. There's definitely more complications with this but this is a huge, huge amount of capital sitting there with investors who are getting towards retirement age, or just own their building for a good amount of time, and maybe they are tired of managing it, and they want to 1031 into a syndicate where it's completely passive. They don't have to do anything. They don't have to personally guarantee the mortgage. They don't have to manage the property, or find the new opportunity, or put together the rest of the capital. They can own a small share of a really big building. They can 1031 into even a bigger building they could ever imagine by just using their 1031 capital. We have one individual who's looking to selling a condo of theirs. They've owned for 30 years now, retirement age. It will sell for about $120,000, where $120,000 will get you maybe a $300,000 or $400,000 property, or may a three or four-family which really don't cashflow that well. Now by working with us, if we created Delaware State Trust, we can have that individual sell their condo, take that $120,000, put it into a trust with us that we can then buy. Let's say we have five other people also 1031 their properties, and we put together another $1 million, or we can go buy a $4 million or $5 million building now. We're right there. We allow that investor to instead of being an investor in a high risk, two or three-family property, where you lose one tenant and you lose half your income, and you start writing a check to pay the expenses every month. Instead, though, you get a small piece of a big building, a much safer investment, a more lucrative investment, a better way for people to put their 1031 equity into a nice, passive cash flow opportunity. To do that, got to peoplescapitalgroup.com. Also subscribe to our YouTube channel, Peoples Capital Group on YouTube. We come up with new videos every single week, and our podcast here, our show here as well. We come up with new show every single week. I'm Aaron Fragnito of Peoples Capital Group. Our website again is peoplescapitalgroup.com. If you have a property that you own, and you equity in that property, and you're thinking about doing a 1031, and you're not so crazy about continuing to be a landlord, give us a call. We will help you 1031 that property. We are looking at the option of starting a Delaware State Trust. We're talking to investors that are 1031-ing their property. We just need to line up all the pieces. We're using the right professionals to do that right now. Give us a call. Go to peoplescapitalgroup.com, or call us on 908-464-0400, and get in touch with us quickly because we are lining up a few select investors to do this, and we need to get in touch with you sooner than later because its a little more complicated than just your average; here's the opportunity, okay, send the money over, let's get it done, like a normal syndicate. A little more complicated, a little more moving pieces, so we need to start the relationship sooner than later, and again, that all starts at peoplescapitalgroup.com. I'm Aaron Fragnito. You have a good day.