By on

1031 Exchange Key Terms and Practical Steps For Normal People | Ep 21

James and Jessi exchanging hands
In this episode, we delve into the specifics of 1031 exchanges in real estate investment. This detailed discussion covers the basics of how a 1031 exchange works, its history, and the crucial timelines and rules investors need to adhere to. We explore various scenarios and discuss important concepts like the identification period, exchange period, boot, upleg, and downleg properties. Our conversation also touches on the nuanced tax implications, the role of qualified intermediaries, and the types of properties that qualify for a 1031 exchange. It’s a lot, but it’s all good to know.

Listen to the Podcast

Show Notes

  • 00:00 Welcome
  • 01:16 An Introduction to 1031 Exchanges
  • 05:47 The Evolution of 1031 Exchanges: From Simultaneous to Delayed
  • 11:23 Eligibility and Requirements for 1031 Exchanges
  • 20:32 Exploring Depreciation, Capital Gains, and Tax Implications
  • 25:31 Navigating Complex 1031 Exchange Strategies
  • 31:23 Investing Wisdom and Closing Thoughts

Key Lessons

  1. Know your deadlines: For a successful 1031 exchange, remember you have 45 days to identify potential properties and 180 days to close on one. Missing these deadlines can cost you.
  2. Use an intermediary: Using a qualified intermediary ensures your 1031 exchange stays compliant. This neutral third party holds the proceeds and manages the transaction.
  3. Consistency is key in ownership: The same taxpayer who sells the property must be the one to acquire the new one. This rule applies to personal names, LLCs, or living trusts.
  4. Upleg, downleg, and boot—decode the jargon: Upleg refers to the new property, downleg is the old one, and any cash difference in value (boot) will be taxed.
  5. Plan for contingencies: Identify multiple properties to avoid losing out if your first choice falls through. The more prepared you are, the smoother the process.
  6. Diverse property options: You can exchange one property for many, many for one, or many for many, as long as the total value aligns with IRS rules.
  7. It’s only investment properties: Personal residences and vacation homes don't qualify for a 1031 exchange unless they are converted into investment properties first.
  8. It's all about intent: Ensure your property is held for investment purposes for at least one to two years to demonstrate intent and avoid tax issues.
  9. Consider the long game: Keep deferring gains until you pass away. When you do, your heirs get a step-up in basis, potentially eliminating deferred taxes.

Watch the Podcast

Read the Transcript

James: Welcome to the Furlo Capital Real Estate Podcast, where we dive into the intricacies of investing in real estate. And our goal is to do something is to equip people to invest wisely in both property and people so that together we can build our wealth while improving housing. I'm James and this is my wife, Jessi

hi, I'm here. You're here.

Jessi: Yep.

James: I'm a little

Jessi: sore.

James: What are you sore from? I

Jessi: started a new Pilates workout series. I don't know what you call that. I don't know.

James: A series that implies like you have a definite start and stop.

Jessi: Well, I don't know about a stop, but I, I ha I signed up cause I needed some motivation and so I joined this.

It's like a 28 day challenge. Oh, okay. And then after that they have, you know, there's other videos. Oh, okay,

James: cool. So you're sore or

Jessi: whatever. Yeah. Which is good. It felt good to actually do something again.

James: I am also sore, but for a very different reason. I just had an entire unit off of our eviction podcast where I went in and I completely redid the flooring.

And so I am sore from doing all that. Yeah. Did some other improvements along the way, but but it's all good. You know what? It's done. And I'm talking to to tenants now. So yeah, it's all good. But I actually would prefer that we spend our time doing. Or dining a little bit deeper on our topic from last week.

So last week we talked about that appreciation no, no, the the depreciation recapture and how the different, how is it a different tax rate than the capital gains. Right. And in there we kind of hit around the 1031 idea, but never really just were like, here's what a 1031 is. And so. I'm going to start this by saying everything I'm about to say, you should run by a tax professional and a 1031 professional.

This is for entertainment purposes only. Now now my goal is for this to be just a really good resource for you in the future to, or now, to go like, Oh, okay, this is what a 1031 is. So my goal for you is for you to be able to confidently go, yes, this is what a 1031 is. And here's how it works. And I've spent some time doing the research.

I managed to fill up four pages worth of notes. So we're going to be here an hour. No, I'm kidding.

Jessi: Amazing. Maybe this is part one of 1031 exchanges. Nah,

James: we're going to nail it all in. I just have a lot of notes, but it'll go fast.

Jessi: I was recently talking to someone about taking a complicated, we were talking about theology, but taking a complicated concept into account.

and boiling it down into five year old words.

James: And

Jessi: I was like, that's what it made me think of was like, could you describe this to a five year old? And have them be like, oh, okay, I get it. Yeah,

James: I think they're, I think they're a big level. Absolutely. That won't be a problem. I think there are other terms and definitions that people throw around that I think are good to know.

And honestly, there's times where I'm talking to people. I'm like, are you just showing off that, you know, the words, like it gets very insidery, very quick. Like people are like, what about that boot? What about your up leg? What about your basis? I'm Yeah. Cool. Good. So we're talking about all that. Eventually.

Okay. And my whole goal and part of this is to throw in a really cool fact where you go, Oh, I didn't know that. That'll happen early on. Okay. All right. So let me quiz you first. Do you know what a 1031 exchange is? Well, let's see what I'm working with.

Jessi: I, I think I know the basics because we did one.

James: Yeah.

Jessi: And so, I mean, I don't know all the intricacies. We're going to talk about that. That's what we talk about on this podcast.

James: To help you invest wiser in property and people. The

Jessi: big idea is you, you have a property and you've had it for a while.

James: Huh.

Jessi: And now you want to sell it, but you don't just want to collect all of the profits and have to pay taxes on it.

There's this thing that you can kind of you sell and buy at the same time, kind of, I guess. So it's like you're selling yours, and then you're rolling whatever income, profit from that. Directly in, yeah, the gains, directly into another property that has to meet certain requirements, like be more, be worth more, or something like that.

Typically it's like bigger, you're like rolling it into something bigger.

James: Like the profit

Jessi: becomes your down payment kind of thing.

James: Yeah, so here's my simple definition. A 1031 exchange is a swap of one investment property for another. That allows your capital gains to be deferred. There you go. And so the theory behind this tactic is that since you, the taxpayer are merely changing the form of investment without realizing a cash gain, there's therefore no immediate imposition of taxes.

No, like, cause you're just, you're like, you're cash never touches you. You're just swapping properties. Yeah.

Jessi: It's almost like if you think of the property as like a savings account, you're just. Moving it from that one into a different one. Or it's more like an investment account, I guess.

James: Yeah, yeah. Those are good ways of putting it.

You're not

Jessi: taking your money out and therefore paying fees and taxes and all the things. Yeah,

James: you're literally just transferring it. Just moving it. When it was first introduced in, do you have a guess when it might have been introduced? What year?

Jessi: I don't know.

James: 1921. Oh. So it's been around for a little over a hundred years.

So when it was first introduced, that was yeah, the idea was. Exactly. Like to do a like kind swap. Now what's interesting is that at the time it had to be, they didn't have this language back then, but now they would call it a simultaneous swap. So at the same time that you closed on, at the same time you sold your old property, you had to buy the new property.

It was all done simultaneously. And then in 1979, things changed a little bit. So that's the way it was, which you could see, like, that's hard, right. To try to line up everything perfectly

Jessi: to get it

James: just right. Well in 1979, again, things changed. There was a court case called Starker versus United States.

Do you know who, I don't

Jessi: remember the Starker in Oregon?

James: Yeah. Not just Oregon. In Corvallis, there is a Starker family that owns over 90, 000 acres of timberland, and they were doing this thing, and what they did, and sometimes you'll call this, you'll, you will hear this called a Starker exchange.

Jessi: Yeah, I have heard that family.

James: Yep, that's the exact same thing. But what they did was they they weren't, they didn't want to do a simultaneous swap. And so what they wanted to do was what they call a delayed exchange. And so the idea was, well, we're going to buy a new place. We just aren't going to do it right away. That was the entire thing.

And so they went through this court case and ultimately the court decided, you know what? You guys are right. This is totally fine. And so based on that, they established timelines for you to be able to do it. So now there's two parts to this. On doing an exchange. Okay. There's, let's see, there's the 45 day period, and they call this the identification period, and that is where you must identify potential replacement properties in your exchange.

Jessi: So you don't have to identify the exact property you're going to purchase.

James: You just have to identify at least one. I think you get up to three. Something that could work. Correct. And then once you've identified it, then you have to exchange into one of those.

Jessi: Oh. Yeah. So you can't do, you can't say it will be like these and then find something else.

James: Correct. Yeah. It's got to be something that you. And it is exactly 45 days. Don't try to do 46. That will cause a problem. It is a very strict timeline, and that was part of what was determined by that court case. Now, once you've identified it, the entire So at

Jessi: this point, have you already sold your property?

James: Yes. Yes, yes, yes, yes. So the clock starts when you have officially closed on the property you've sold.

Jessi: So another buyer has bought your property, you close on it, you have cash,

James: or the

Jessi: funds from that sale that now you are moving. Yes. But now you've got 45 days. So, I mean, you should identify something probably before that.

It depends, you know? Yeah, yeah, ideally, yes. Or at least have an idea of like, okay, yeah, things exist that I could invest in or exchange into.

James: Yes, and then the entire exchange period, and I'm just double checking that this is what this is called, because again, I had to do all the research for this. The entire, yeah, it's called an exchange period, is 180 days.

And that is when You have to buy and close on the new property, one of the ones that you've identified. So now when I did mine, we were doing three properties into one. And I was able to time all of them. So they all closed within a week of each other, which was great. And by the time I closed, I had already identified and had the new one under contract.

So, and I was able to do all of that within like 30 days. So, I, so for my exchange, I was very easily able to be like, yep, here's the property address. And it's like a, like a three line form that you fill out and sign, that's it. And you go, this is it. And then you're off to the races. So mine, I kind of like, I identified it and then close, like it was all in the same signing essentially.

So it was super easy. But yeah, no, that's the, and there are people who will freak out, right, because they'll identify something and then maybe someone else swoops in and buys it. You go, no, no, don't do that. Or you find out something on the inspection and you go, ooh, this is not nearly as good of a deal as I thought.

Jessi: Is that why they make you find multiple?

James: That's why they suggest you do it. You don't have to. They suggest you. Yeah. Yeah, like I didn't technically, because I had mine under contract and I was moving forward with it.

Jessi: Had you already done inspections and things?

James: Yeah, yeah. I was closing on the property.

Like, I was in it to win it. But I had like 15 days of buffer, just in case something fell apart. I could if I needed to, last minute. And it could be anywhere in the United States. It doesn't have to be local. So there's some options there. There's some other things that are worth paying attention to. But anyway, so, 45 days.

To identify 180 days to find a new one. Those are like really, really, really important numbers to know and to pay attention to and not forget about. Here's the other thing you have to kind of declare that you're doing this ahead of time before you close on the property. So you can't. Close on your property and then a week later go, man, I'd love to do a 1031 exchange.

Jessi: And yeah, I imagine they hold the funds from this. Yeah.

James: So there's a term.

Jessi: Like the title company holds on. No, there is

James: what is called a qualified intermediary. Oh a Qi. Mm-Hmm. . Totally separate party. They act as a neutral third party to facilitate the exchange. They hold the proceeds from the sale of the relinquished property.

Mm-Hmm. . And use them to buy the replacement property, ensuring that the investor does not take possession of the cash and trigger a taxable event. Makes sense. That was another change that they made in the rules because of the starker exchange. Because you remember before then. There was no deferral. Yeah, it all had to happen

Jessi: simultaneously.

So it didn't matter. It was like a double close, essentially.

James: So once that came along, they had to set rules to be like, alright, here's how we make sure this all stays above board. We're

Jessi: right, because otherwise

James: So you essentially have like two escrow people. Get your cash,

Jessi: skim some off the top, and then roll the rest in.


James: Yeah, no, totally. Yeah, so, question is What can you exchange?

Okay. All right. But can you be more specific? Cause it's not just anything.

Jessi: Oh, well it has to be income producing property, right? Huh. Yeah. It has to be it could be residential or land. Yeah. As a lease on it. Maybe,

James: It

Jessi: is business.

James: It is real estate held for investment business or trade purposes.

Jessi: Okay. So like farmland.

James: Yes.

Jessi: Totally cool. Because you're doing a business on it. True. And you can do

James: duplexes into warehouses. Yeah. Which is what we did. You, in theory, could do a landless health enhancement. Does it

Jessi: matter what type? To what type? So, like, if you wanted to exchange farmland into, like, apartment buildings, or Nope.

That could be whatever. But

James: it can't be my personal residence.

Jessi: Right. Can't do that. Or it

James: can't be a vacation home.

Jessi: What if you were running a business out of your personal residence? No,

James: because it has to be a fraction of it. Yeah, that gets tricky. No. What a lot of people will do though, I think this is kind of fascinating, is they might have an investment property, and then they swap it for something else, for like an Airbnb, and then they have it as a business for like three years, and then they kind of go, and now it's a vacation rental.

There's our dog again. Little guy, I love it. You, you and then you kind of go, and now it's a vacation rental because you've had it for that period of time. If you ever go to sell it, it's issues you like, or what they'll do is they'll do the opposite. Maybe I had a vacation rental or no, no, actually what they'll do is they have a primary residence.

And let's just say, like, if it's your primary, you automatically get to deduct a significant amount of that capital gains. Just go, it just doesn't count. But let's just say you live in an area where prices are really high, or you just have a ton of capital gains sitting in there. You might say, well, I'm going to turn it into a rental for two to three years.

I can't remember which one it is now. I probably should have looked that up. And then you go, and now it has been a business. Because you can't just be like, Oh, I have it as a rental for one month. Now I can 1031 exchange it. There's kind of like a season period there. But yeah, so like kind is any real estate held for investment business or trade purposes.

So it's relatively well known. The other one is that it must be located within the United States. Can't do international properties.

Jessi: Bummer.

James: Bummer. Yeah, so we can't 1031 we can

Jessi: Airbnb. That'd be so

James: awesome. That, that is definitely a dream purchase. Oh, man. Yeah. So, let's see here. For business use. Oh, I do have it on the Oh, yeah.

No, no. There's we'll go with this. Yeah. Okay. This is nice to know. It's my notes. I wrote typically a holding of a property is for at least one or two years is advisable to demonstrate investment intent. So that's interesting. So there's not a heart, which is why I didn't know the number. There's not actually a hard and fast.

There's just, you have to be able to demonstrate intent. And that's why I think people like, yeah, two to three years definitely demonstrates intent product. It's going to depend on your risk factor and how much you don't want to get audited, I suppose. Investment for business use. Let's see the relinquished.

Yeah, they just both, they both must be that. So yeah, rentals, rentals are totally okay. There's some other qualifications. I think this one's interesting. You have to have consistency in ownership. So the taxpayer who sells the relinquished property must be the same taxpayer who acquires the replaced property.

Jessi: That makes sense.

James: And the way the property title is held can affect eligibility. So So sometimes, so there's two situations here that you need to be aware of. When we first bought our duplexes, we bought them in our own name because we had no assets that were worth protecting. Eventually we had some more and we formed an LLC and we retitled all of our properties in to be owned by that LLC.

Does that make sense? Yeah. And. Now, the loans are still guaranteed by us personally, like that didn't change and there's kind of a little carve out in a lot of loans that's all like, yeah, if you do that, that's totally cool. Like you could do the same thing with like a living trust and that kind of stuff.

Like they get it. There's these things that happen. As long as say the owner is, the owner of the LLC is the same as the original owners, they get it. It's just a renaming thing. But the important part is that LLC now has to own that new thing.

Jessi: Does that make sense? Yes. You can't. Exchange it and put it in our names again.

James: Or have gone from like, Oh, these are our names to an LLC and LLC. And again, is there a seasoning period there? Probably, probably a month or two, something like that, just to show, make sure all, all the systems update since it's not in the blockchain and happen instantly. The other thing that makes this really interesting is from a syndication standpoint.

So if you remember, a syndication is a group of people who essentially put money into a company, form the company, and then the company goes and buys that property. So if the syndication, if the syndicate wants to do a 1031 exchange, the syndicate has to go from this property to this property. Now in theory, you can sell and swap shares of that company, and it's still the company, but that's messy.

As you can imagine. Transcribed

Jessi: Seems a little messy.

James: Some people, like, they're willing to do it and go through that whole rigmarole. It's a thing. But, as a general rule, you don't 1031 syndications. Just because you've got investors who want to get their money out. And in this case, you're like, Sorry, we're keeping on rolling.

Yeah, syndication. By rule, you don't get any.

Jessi: Right. That 1031, to me, seems more like that same concept of a savings account. Yeah. Whereas a syndication is It's an investment that has a quicker return. Yeah. More like a CD, I guess. If you're using the banking analogy, it's like,

James: 1031

Jessi: is a savings account.

Syndications is like, you put it in for a time and then you get it out. Yeah.

James: Money marketing? I don't see it. Yeah, sure. Whatever. I'm gonna let you just hold on. It doesn't

Jessi: sit.

James: I'm gonna let you hold on to that one. Whatever.

Jessi: Normal people can understand banking terms.

James: Okay, here's the other here's the other piece.

It has to be, the replacement property has to be of greater or equal value than the relinquished property.

Jessi: Okay, that was, I kind of tried to say that earlier. In order to fully

James: defer all capital gains taxes.

Jessi: Yeah.

James: Okay? And this often means that If you have a loan on the property, you're probably going to get a loan of equal or greater value.

So you can't say, so for example, let's just say you've got 600, 000 worth of gains, that you want to move into something else, which was our situation. Yep. You can't, and let's say the value of those properties, we'll just make it up was a million dollars, okay? Because you had a 400, 000 loan. You can't go off and say, Oh, I'm going to go buy a 800, 000 property.

I'm going to roll my 600 into it and get a loan for 200 and doesn't count because you're short. It has to be at least a million, which means chances are you're going to get another loan of equal or greater value as well, typically, which is interesting. It makes sense. Now, if that replacement property is a lesser value, you can do it.

But you will end up paying taxes on the difference. And there's a word for this for some reason, it is called boot. And I did not go far enough down the rabbit hole to figure out where did that word come from? There's a couple other terms like that. Which I think are kind of related to it. There is a term called upleg and downleg.

I had to look this up. I constantly get it confused. If you had to guess what is the upleg and the downleg.

Jessi: It refers to the property that's worth more or less.

James: Ooh, close. It has to do with the relinquish and the replacement property. Okay. Which one is which?

Jessi: The upleg is the replacement.

James: Okay.

Jessi: And the downleg is the relinquished.

James: Why do you think that? You're totally right. That's right.

Jessi: I think it's cause it's like. Up in my mind is like, you're moving up

James: and you're

Jessi: leaving that one in the past down there. Okay.

James: And so I'm desperate if I'm totally

Jessi: making that up,

James: but those are totally words. Those are words that people throw around where I'm always like, ah, I feel like I should know this.

So for me visually, I'm with you. Right. Instead

Jessi: of saying the property that you're going to Purchase or like the new property replacement and relinquish. Yeah, it's like,

James: yes, up, leg, down, leg, up, leg,

Jessi: down, leg. It's yeah, no,

James: totally. And then if you think about the boot, it's this thing that's on your foot and you're kind of kicking it off.

So it's not like it's not a part of the leg anymore. It's this extra thing. And now you gotta pay taxes on that and you would kick it off when you go and you kick down. So that's like your down leg. There you go. As opposed to you figured it out. This is why they, I figured it out. This

Jessi: is why they named it.

I figured it out. .

James: Yeah, no, exactly. So anyway, so that's that term. So we already talked about the qualified intermediary the person we used up in Portland. Mm-Hmm. , they're awesome. There's a little bit of a fee for it, but honestly it was like, it was crazy reasonable. So why would you ever do this?

What's the point of it?

Jessi: So you don't have to pay taxes on your money. Because at some point your, your property stops appreciating.

James: Nope.

Jessi: Well, it, you can't depreciate it anymore.

James: Okay, that's fair. Ooh.

Jessi: Is that why you would exchange? That is very separate.

James: No, depreciation is a total separate beast. I mean, okay, all right.

Jessi: Cause you don't want to hold on to your property forever. So when you are deferring,

James: you are also, not only are you deferring your capital gains, but you are also deferring whatever depreciation recapture you might have to pay.

Jessi: Okay.

James: Which, again, is taxed at an ordinary income tax. So you are, so technically there's these two things that you're

Jessi: deferring.

James: We all talk about the capital gains, but it's technically both. It's depreciation recapture and capital gains. So yeah, that's part of it. You don't want to have to pay that back yet.

Jessi: Yet.

James: Yeah. Yet. But, whenever you do end up selling it, if you, the owner, end up selling it, then you gotta pay all of that back.

Depreciation recapture at ordinary income rate, capped at 25%, and capital gains, which is 15%. Plus whatever your state has, which in Oregon is 9. 9%.

Jessi: Yay! I thought that was the primary reason for doing it, is that if you, because if you sell a property like normal and you get your cash, you have to pay something out of your profits.

Whereas this one, you get to reinvest all of your profits.

James: Yeah, and so in theory you can compound faster. One really cool thing, I think you already know this. What happens if you die? If you die in the middle of a 1031? Well, just, just in general. Yeah. Like, yeah, you've been 1031ing for years. You're now 97.

You pass away. What happens to all of that deferred capital gains and depreciation recapture?

Jessi: Goes to whoever you stayed in your will.

James: Nope. Resets, disappears, it's gone. So whoever inherits your property, it's as if none of that ever happened. They inherit at the new rate. There's another word here. It is called basis.

Let me make sure I get this, the word right.

Jessi: So fast forward this.

James: So basis refers to the original value of the property for tax purposes. And so in a 1031, the basis of the relinquished or downleg property transfers to the replacement or upleg property, potentially adjusting for any additional investment, whatever, blah, blah, blah.

Jessi: So fast forward, let's say we have this million dollar property.

James: Yeah.

Jessi: And, and we have, I'm just trying to fully understand. So we have. The downleg amount that we've put into it of 600, 000 and then we took on the loan for 400, 000. Yeah. We deferred paying taxes on

James: that 600, 000. Yeah.

Jessi: We deferred paying taxes on the 600, 000.

So now we, we die and our kids, which who we've said in our will, like they're going to get this. They don't have to pay taxes on that 600, 000 ever.

James: Yeah. It's as if they bought it for a million dollars.

Jessi: Interesting. So if they, if they just sold it,

James: there'd be zero gains, zero, zero gains and zero depreciation recapture.

Jessi: So, but it's not

James: what,

Jessi: well, it's already been 1031 exchanged.

James: Yeah.

Jessi: And so at this point, if they sold it, they would, it would just be like a sale, wouldn't it? Yeah. Huh. So they would have to.

James: No. No, because it would be as if they bought it for a million dollars and then they sold it for a million dollars.

How much money did they make?

Jessi: Oh. But what if they sold it for 1. 5 million dollars? They'd,

James: oh, they'd have to pay on the gains for that half a million dollars. But not 1. 1. Weird.

Jessi: There's something I'm not following there, but.

James: Oh, it's just, the whole idea is for whatever reason, capital gains, taxes, and depreciation recapture, taxes, are with the person, not the property.

So once you're gone, taxes aren't owed anymore. Huh,

Jessi: but that's only with 1031 exchanges.

James: No, that's true for all property, all real estate.

Jessi: Well then why did you point it out for 1031 exchanges?

James: Well, just cause, it's, because. Because what it allows you to do is you can keep rolling, rolling, rolling. And then yeah, it's whatever that final property is, all the normal rules kick in.

So it's just one of those, in theory, people say, well, I defer forever. And when they say that, what they're saying is I'm just never going to sell my properties. I will die while owning them. And then it will be inherited by someone else. All the basis resets to zero and then they can do whatever they want with it.

They can sell it, take the cash or they can roll it into something else. Doesn't matter.

Jessi: Yeah, yeah. Seems good.

James: Yeah, seems good. Obviously the downside is that it's just, it's complex. It's a lot more complex than normal. So here's something that I was interested in figuring out. What can you use the funds for?

Or a better way to say it is can you use the funds for anything other than, like say you're down payment or buying the property?

Jessi: Well, if it, I don't know if it's it said in there has to be something of equal or greater value, but I was always under the impression it had to be like real estate, some sort of real estate or land or

James: for the purchase real property. Yeah. Okay. Here's where I don't know if you could buy a business where it's hard to work with.

No, it's the answer. Yeah. No. I guess for me, what I was interested in was, could I, let's just say, let's use the 600, 000 example, right? Could I buy a property? Put, let's say, 300, 000 down and then put 300, 000 into repairing the property to make it now worth more than that, than the downleg property.

Jessi: Yeah, so can the, can your exchange money, your downleg value be used, does it have to be used for the property cost or purchase price only?

Or can it be used for repairs, improvements?

James: Here's where things get complicated. As a general rule, no, but if you can do all the improvements and repairs needed and you can do them all before it's officially acquired before you will close, which means if you can do all those repairs within the 180 day period, then yes, you can do it.

Jessi: Weird.

James: It's really complicated. So why, why, what?

Jessi: Yeah. Like, why would they put a time limit on it, I guess?

James: Because in theory, it's, it's all supposed to be, it's supposed to be that whole like for like thing. Yeah. And so that's the entire idea, and doing repairs are not like. It's something that's different, and timelines can get weird.

But it's a weird, so in theory, you could get a property, get it under contract, and part of that contract says, Hey, I'm going to essentially do a build the suit type of thing. I'm going to do a whole bunch of repairs. I've got it on a contract. Like I am buying it. We're moving forward.

Jessi: And it can be, but the cost of those things can be pulled out of the

James: correct.

I do the exchange fund exchange. Now, obviously if your repairs take a little longer than 180 days, that's your risk. because the entire thing may not count. Like all of those, like, let's say I get 250, 000 into this fictional repair that I've come up with. And I'm just like, I'm short, but I'm not going to finish on time.

So I'm like, well, we got to close no matter what at two 50. They go, Hey, guess what? That is boot. You got to pay taxes on that. And now I'm like, Oh, but I already spent that money on the repairs. I don't have the cash available to pay that depreciation recapture of 25%. So it's a risky, complex situation. You really got to know what you're doing, which is why as a general rule, don't do it.


Jessi: that doesn't seem smart.

James: Yes, but you can. They often call that a construction exchange. It's often what's that called? All right. Let's see here. I want to, Ooh, here's another one. It's even crazier. It's called a reverse exchange. Want to guess what that means?

Jessi: Guessing you're pulling cash out on some level.

James: It's all about timing.

Jessi: Oh,

James: yeah. So you have a simultaneous exchange, which was how it was originally written. You have a deferred exchange,

Jessi: the reverse, you find your up like first purchase, purchase it, get it under contract and then say, But I gotta sell that one to pay for it.

James: Yeah, essentially. Yeah. Yeah.

And somehow you've got the other person to be like, yeah, that's all cool. I'll wait to receive the funds until you close on your other one. I

Jessi: could see that for someone if they're like, you know, they're retiring. And so they've come to you and they're like, Hey, we have this, this property, this business. We don't need to sell right now.

We're not highly, you know, we're not at a place where we have to.

James: Technically sell, but keep going. But.

Jessi: We're willing to wait for

James: you to set up this transaction.

Jessi: And

James: so you go, alright, cool. Let me at least close on it. Start taking over, do whatever I'm going to do. Start improving it. And then once I finish the exchange on this end, You get all the cash.


Jessi: Yeah,

James: so it doesn't happen very often for obvious reasons. Sure. Like most people are like, oh, I'm not gonna do that. Yeah,

Jessi: most, most of the time I would think it, like, it's a, seller who's looking to put their money into something else.

James: And and another thing to remember when you're talking about the relinquish and the replacement in terms of value and like for like, it doesn't have to be one for one.

You can do many to one.

Jessi: Yeah. Right.

James: You can do one to many.

Jessi: Yeah.

James: You can do many to many. The value,

Jessi: the valuation of it has to be. Correct. within

James: which made a lot of sense, because you might as well just split those up into a bunch of one to many, but whatever. But you could do it. There's no, there's not a lot of restrictions as long.

And again, if even if the value is less, you go, okay, whatever, I'm going to pay my taxes. And as long as you plan for it, you're okay. Yeah. Yeah. So that was 1031 exchanges and how they work, hopefully. It makes sense on what it is. And we talked about a whole bunch of different terms and the process and how it works.

There are all sorts of additional caveats and trickery and questions. I have sat in through multiple one hour long presentations, all about 10 31s. By actual professionals. And, but usually they spend half an hour saying here's what you can't do.

Jessi: Which kind of makes sense because there's lots of rules.

Well it turns out

James: investors like to push the envelope too on what we can and can't do. But how about this? Oh, totally.

Jessi: You know what this actually reminds me of that's like not related at all really? But this is how I was as a kid. I remember I loved pennies as a kid. Yeah. And I just always wanted more pennies.

And so my grandpa would trade me, like if I had a dollar or something that I had earned, he would be like, ooh, I'll give you these like 10 pennies for that one dollar. I'd be like, yes, that's a great exchange because I'm getting so much more. So don't do that in your 1031. Slightly different. The valuation is very different.

James: Yes. I mean, unless the value is number of pieces. Man, I

Jessi: thought I was winning big. Yeah, yeah. I collected so many pennies. That's

James: funny.

Jessi: Once I figured out that a dollar was worth a hundred pennies, I was like, hold on a second. Wait a

James: minute. That's funny. That's awesome. Yeah. All right. Well, there you go.

That's 1031. Hopefully that was helpful to everyone listening to this and they go, yeah, I've got this. And this is one of those I'd like to think is a book market type of thing because we've covered a lot of stuff. And if you have a friend who's like, hey, how does a 1031 exchange work? Boom, send them this.

They should have a really good idea for how it all works. That's the entire point of this, just to help you as investors invest more wisely, like we were talking about. So with that, I want to thank you so much for listening and if, and we would totally appreciate it if you would leave a like or review wherever you listen to your podcast.

And if you are ever interested in learning about investing with us and what that might look like, please visit us online at furlough. com love to start up a conversation with you via email. It'd be awesome. And with that. Have a great day.

Let's build your wealth and
improve housing, together

Share what you learned

Furlo Capital Podcast

Furlo Capital
Real Estate Podcast

A conversational podcast between James and Jessi Furlo that dives into the intricacies of passive real estate investing. Our mission is to equip people to invest wisely in both property and residents so that, together, we can build wealth and improve housing.

Listen Anywhere

Let's build your wealth and improve housing, together

Passive Income

Tenants pay monthly rent, which covers expenses and generates a profit for investors. Plus, multifamilies appreciate and usually sell for a significant profit.

Consistent Above-Average Returns

Real estate is less volatile and historically outperformed the S&P 500 by routinely generating average annual returns of at least 10% after fees, inflation, and taxes.

Revitalize Local Communities

We give people a great, safe place to call home. This doesn’t hit the spreadsheet, but every property is managed and maintained with the residents as a top priority.

Extraordinary Tax Benefits

Your income is taxed much lower because of depreciation and because it’s taxed at a lower capital gains rate.

Below-Average Risk

More units mean less vacancy sensitivity. Plus, costs are distributed across a larger number of units, which also allows us to hire a professional property manager.


Unlike stocks, lenders like to finance multifamilies and the loans are tied to the property, not the person. This accelerates wealth building.