Introducing the 1031 Exchange

Wally Smith:
Tell us about 1031s.

Jeff Hertz:
1031s. I think we just surpassed 100 years that it’s been on the tax code. It’s evolved over the years. It’s both expanded and contracted. In some cases they talk about in the early days, simultaneous exchanges to farmers, trading deeds across the table. Very straightforward, very simplistic. But the idea that if you’re in, and this hits home to me because I spend a lot of time in places like Iowa and Nebraska, Minnesota where there’s lots of farmland. If you’re trading one piece of farmland for another piece, there might be differences in quality, but at the end of the day it is like kind. Right. So that term-

Wally Smith:
Absolutely.

Jeff Hertz:
… it was apropo in terms of how it was created. Now, of course, over that 100 plus years we’ve seen a great expansion of kind real estate. You could sell a duplex and invest into an office building or an industrial property. So like kind is quite broad.

Wally Smith:
Mineral rights, water rights.

Jeff Hertz:
Even things that are beyond real estate. And of course up until a few years ago, you even had what are called personal property exchanges. I could sell my Learjet and buy a Gulfstream. I could sell a Picasso and buy a Rembrandt. That of course was taken out in 2017, so were really back to more-

Wally Smith:
It was probably appropriate. I think they were abusing it a little bit.

Jeff Hertz:
The fact that you could sell a wine collection and 1031 exchange it, seemed a little odd.

Wally Smith:
You sell a restaurant, include all of the equipment and the wine collection.

Jeff Hertz:
It’s ironic my last name being Hertz, I worked with some firms that did rental car swaps. And so they would sell off, Hertz would sell off hundreds and thousands of vehicles, avoid the depreciation recapture by reinvesting the money into new cars. It was part of that industry, but ultimately I’m not sure that it really made sense as far as it being a relief for taxpayers who were seeking that.

Wally Smith:
I welcomed it when I saw there were a lot of folks were saying, it’s heavy handed government again, but I think actually every tax cycle has been on the chopping block. It’s looked at so many people as a gift to wealthy people or a gift to generational wealth, but it’s not. It is bedrock of capitalism, being able to keep your capital, keep your assets working productively. I’m glad they cleaned it up, I think that protected it for a while.

Jeff Hertz:
But keeping maintaining the 1031 code I think is important. Again, going back to some of the experiences I had years ago, you have multi-generational farmers and landowners and what’s happening in a lot of cases there is the kids that grew up on the farm now have moved to the city. They moved out of the area, and they don’t really want to continue to own farmland that is in where they grew up. And so having that ability to transition vis-a-vis 1031 exchange into other assets, maybe things that are more in their area of expertise, maybe geographically make more sense for them not to be burdened by having an asset that you just long term don’t want to own, can be very helpful.

Wally Smith:
We had a client come in, they are fifth generation, the clients are all in their 70s, and the land up in the Dakotas has been in the family for five generations. Nobody wants to work it now, and it’s just lying there. They’ve got people willing to buy it, but they’ve been scared of the capital gains. So the whole concept of 1031 into something that preserves the tax benefits, but is income producing, it’s been a tremendous tool really.

Jeff Hertz:
And personally I was involved in a family situation where you have family members who are co-owners of assets together and disagreements and lifestyle, people move to different areas of the country and don’t necessarily want to be tied to that. So it’s like the prisoners being handcuffed to each other. You don’t necessarily want to go the same direction as your family members. And quite honestly I’ve seen situations with siblings who are not even on speaking terms any longer and say, it doesn’t make sense for us to own this asset collectively. So to be able to unwind from a logistical standpoint can be very helpful.

Wally Smith:
Well, let’s talk about that a little bit. The rules are as clear as IRS can make them sometimes, and we hear many, many things about the structure has to be identical before and after as far as who owns the property, what’s the registration of the property? We talked to various QIs, some of them are the big guys, of course they are by the book, because if they blow something on one of them, it’s going to open up their entire book and all those clients basically to audit.