1031 Exchange: Modeling the Impact
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None of Tactica's proforma tools touch the post-tax implications of multifamily investing. Recently, we partnered with 1031 Specialists, a Qualified Intermediary that facilitates 1031 exchanges so real estate investors can defer their real estate taxes and compound their wealth.
1031 Specialists has meticulously crafted an Excel calculator template specifically for 1031 underwriting. When used with the pre-tax Tactica underwriting tool, this template can significantly impact the strategies of even the most astute investors.
Today, I plan to walk you through a case study where we use Tactica underwriting runs to populate the 1031 analysis spreadsheet and show you some of the synergies between Tactica proforma tools and the 1031 Specialists analysis template.
Tactica Tools Referenced in the Tutorial
Tactica Free MF Proforma Template (Relinquished Property)
Tactica's Value-Add Model (Prospective Property, aka “the exchange”)
1031 Specialist Tool
Disclaimer: The content provided in this tutorial is for informational purposes only and should not be construed as tax advice. We recommend consulting a qualified tax professional for advice tailored to your circumstances.
Selling a Property
Let's say we've held a property for four years and want to sell it. I am using Tactica's free multifamily template for this exercise, which I altered as a "hybrid sell vs. hold proforma template."
The blue columns are "actual" historical financials I overwrote in the initial proforma. I manually entered the current offer of $8,950,000 and the cap rate (6.44%) for Year 4 NOI.
Now, let's take a look at the “1031 Exchange Calculator.”
I circled all the data points we can pull from the proforma of the property we'll be selling. Most of these data points are on the "Valuations" tab.
You'll spot the broker's commission, other allowable expenses, and closing costs on original purchases on the "Summary" tab:
You can copy and paste this info directly into the “1031 Exchange Calculator.”
Note: I aggregated all other closing costs upon sale at 1%, so I will group that all together for now. Brokerage fees, title fees, and other qualified fees should total $223,750.
We can confirm they do ($134,250 + $89,500).
You should also add the 1031 Specialist's $1,195 fee to the proforma closing costs, although it's immaterial for a deal of this size.
Note: I put in a ballpark estimate for "depreciation" over the four years ($952,000), but your real estate accountant must provide this precise information. They should be able to reference tax returns to give you the accurate amount. Also, confirm with your CPA which closing expenses qualify both on the front and back end of the relinquished property!
With this section of the template filled out, the 1031 template will tell us capital gains exposure and estimated taxes for:
Federal
New Investment Income
Depreciation Recapture
State
Capital gains exposure totals $1,698,618, and all taxes total $619,185.
Exchanging Into a Property
The next step is entering details about the property you'll purchase.
I grabbed this data directly from the prospective deal I keyed into Tactica's Value-Add Model.
The prospective deal we have underwritten is large enough for all capital gains to be fully covered by the 1031 exchange. The taxable boot = $0 off to the right confirms this fact.
The template will provide enlightening feedback if you have multiple prospective projects in the fold, maybe some that do not cover all tax exposure. For example, let's change the exchange property to an $8,000,000 purchase and assume a 65% LTV (or $5,200,000 down payment).
Because the new property costs less than what we sold the old property for, there is a taxable boot of $725,055, which means the seller is on the hook to pay taxes on that amount. While this is better than not exchanging at all (total capital gains exposure was nearly $1.7 million), ideally, you'd find a property that retires the entire boot.
The final section of the model is strictly hypothetical and looks at the largest potential deal you could target in two scenarios:
Partaking in a 1031 Exchange
Forgoing a 1031 Exchange
By saving $619,185 in taxes, you can now use equity for the next project. Assuming you were to get 80% LTV financing, the 1031 exchange would allow you to afford a $19,290,335 property, whereas you could only afford a $16,194,000 property if you were to pay taxes at the sale.
Summarizing a 1031 Exchange
Tactica proforma templates and models don’t cover post-tax scenarios. Partnering with 1031 Specialists is a great opportunity, as they are Qualified Intermediaries who help investors understand the nuance of 1031 exchanges and ensure they are executed accurately under rigid timelines.
If you have any questions about your project specifics, you can contact 1031 Specialists (the phone number is in the Excel template).
Today, I showed you how easy it is to take assumptions from Tactica proformas and put them into the 1031 template. Ideally, the exchange property is substantial enough to defer property taxes on the relinquished property and help your compound real estate investment growth in perpetuity.
Disclaimer: The content provided in this tutorial is for informational purposes only and should not be construed as tax advice. We recommend consulting a qualified tax professional for advice tailored to your circumstances.
