Ben Mandel 0:00
That 1031 transaction can be recharacterized into a Qualified Intermediary installment sale. And simultaneously the lender is notified and the money is wired to the seller into an account of their choosing. And that process generally takes between 24 and 48 hours.
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J Darrin Gross 0:38
Welcome to Commercial Real Estate Pro Networks, CREPN Radio, Episode Number 251. Thanks for joining us. My name is J. Darrin Gross. This is a podcast focused on commercial real estate investment and risk management strategies. Weekly we have conversations with commercial real estate investors and banks. professionals who provide their experience and insight to help you grow your real estate portfolio. Let’s get into the show. today. My guest is Ben Mandel. Ben is a partner at Capital Appreciation Strategies. He’s also a 35 year finance and real estate professional. And in just a minute, we’re going to speak with Ben about an alternative tax deferral process to the 1031 exchange known as the Qualified Intermediary Monetized Installment Sale. But first, a quick reminder, if you like the show, CREPN Radio, please let us know. You can like, share, or subscribe. And as always, if you leave a comment, we would love to hear from you, our listener. Also if you’d like to see how handsome our guests are, be sure to check out our YouTube channel and you can find us on youtube ad commercial real estate pro network. With that I want to welcome my guest today Ben, welcome to CREPN Radio.
Ben Mandel 2:03
Hello, Darrin, thank you for having me.
J Darrin Gross 2:06
I’m so glad you’re able to join us today. I’m looking forward to our our talk today. And but before we get started if you could take just a minute and share with the listeners a little bit about your background.
Ben Mandel 2:19
Sure. I started my career in a family real estate business and spent 12 years working with the family pretty much developing and selling land parcels and also doing a little bit of homebuilding. Following the real estate business. I became a financial adviser practiced in that realm for 20 years. And for the past two and a half years I’ve been working on educating people about our process a Qualified Intermediary Monetized Installment Sale and helping to facilitate this process for those people who wish to employ when they sell their capital asset.
J Darrin Gross 3:09
Got it. Well, maybe a good place to start just for orientation a 1031 exchange, would it be helpful to at least identify what that is and when it comes into place we can orient as to what what a Qualified Intermediary Monetized Installment Sale is as different,
Ben Mandel 3:39
Certainly certainly. So the 1031 exchange is a section of the IRS code, which was amended in the last year and a half used to be able to be used for all capital assets. Now is only able to be used for real or real property real estate. capital asset in the process allows the seller to defer their tax capital gains tax on the sale of the asset. And what it requires that the seller do is replace the real estate with a lifetime property, which is a very broad definition, they can essentially replace the real estate with any other piece of real estate. They have to identify the piece of real estate that they want to replace what they’ve sold within 45 days from the closing of their sale. And then they must close on that identified piece of real estate within six months from the close of their initial sale. If they fail to do either one of those and the 1031 exchange essentially fails and the seller will have to pay the capital gains tax that was due in the year of sale. If they do identify and close then that deferral can Go on, all the way until they pass away and they can keep utilizing the process to buy and sell real estate current law up until the time they pass and when they pass, the their heirs actually inherit the property with a step up in basis.
So with a 1031 exchange, if utilized correctly, the individual who is selling their real estate will never have to pay the capital gains tax, it will become an obligation of the errors but since the IRS received a step up in basis in the value of the asset if they sell it rather quickly, and they’ll pay very little if to no capital gains tax on that asset. So that’s what a 1031 exchanges is.
What our process does is allows people who want to sell their real estate and any capital asset for that matter. We’re not confined to the real estate capital asset, but it allows those people selling real estate, to not have to reinvest in real estate again, they can reinvest in whatever they choose. There is no light kind requirement utilize our process, and it helps the real estate professional. Sorry, it helps the real estate professional or investor who doesn’t want to identify a property that they want to replace the sold property with within 45 days or close within six months. They’d rather hold on to the cash from their sale, and then reinvest in real estate on their own timeline, rather than on the timeline that the code requires in the 1031 exchange. Example being in a market where people feel that a correction is coming. They may choose that there they may not really want to reinvest, sell at the high point in the market and have to reinvest at the high point in the market. They’d rather hold their own asset and reinvest at a correction at a more favorable cost than they would have gotten if they had had to do the 1031 exchange. So it’s an alternative that allows flexibility with the reinvestment of the proceeds from the sale of the property.
J Darrin Gross 7:18
Got it? So a couple of questions come to mind. In the the 1031 process, you have to identify a Qualified Intermediary. And as you marched on that 1031 process, you’ve got identify three potential properties. Where is it that the Qualified Intermediary Monetized Installment Sale is inserted in the process.
Ben Mandel 7:47
Actually, it’s done prior. While the property is in escrow. The paperwork is set up to create the transaction, the Qualified Intermediary actually closes a transaction as a 1030 Want to exchange and then as soon as the funds reach the intermediaries title company that triggers the intermediary, notifying the independent third party lender who actually monetizes the installment sale to fund that monetization, and then the seller receives most of the money less fees in cash at at typically between 24 and 48 hours after their initial close of escrow.
J Darrin Gross 8:31
Okay, so, example here we’ve got a property we’ve held for a long time. It’s now we we sell it. If I understood you, right, the the sale still goes through the Qualified Intermediary. And then you mentioned the bank or a lender. Can you kind of walk us through that? with that?
Ben Mandel 8:57
I’ll expand on that. The way the training transaction is set up begins while the property is in escrow. The Qualified Intermediary will communicate with the seller and structure a 30 year interest only installment loan. Simultaneously, they’ll arrange for an independent third party lender to monetize that installment loan so that the seller actually receives the majority of their money immediately following closing. And I say the majority of their money there is a six and a half percent fee. For this transaction 5% goes to the Qualified Intermediary 1% goes to the lender. And then 50 basis points actually goes to a long term escrow company that we employ to administer the transaction during the entirety of 30 years. So in other words, the long term escrow company will receive the payments from the intermediary on the installment note, and then make the payments to the lender for the benefit of the seller on the monetization loan. They’re essential. essentially equal payments, both being interest only. And they don’t create a current tax, the escrow company supplies the seller with their 1099 and 1098 each year. And those, those two amounts will offset give an interest income and assuming that the money’s been invested as it should be the investment interest expense so there’s no current tax due. And then finally, at the end of 30 years, the balloon payment is made, which ends the process the balloon payment then is sent to the lender and everything is complete. And the individual or entity receives constructive receipt at which time the taxes are due in 30 years. So that the paperwork is set up wall the sellers and escrow then immediately following the close of escrow, upon receipt of the proceeds by the title company of The Qualified Intermediary, the transaction is recharacterize to a Qualified Intermediary Installment sale, which is allowed for in the 1031 code section that a 1031 transaction can be recharacterized into a Qualified Intermediary Installment Sale. And simultaneously the lender is notified and the money is wired to the seller into an account of their choosing. And that process generally takes between 24 and 48 hours to complete.
J Darrin Gross 11:31
Got it? So when the money goes to the Qualified Intermediary, and then the lender makes the loan, what kind of percentage would would a seller expect to get from the proceeds?
Ben Mandel 11:50
93 and a half percent of the proceeds Okay,
J Darrin Gross 11:53
So it’s just the six and a half percent.
Ben Mandel 11:56
J Darrin Gross 11:58
All right. And then For the life of the loan for 30 years, the there is a payment due for the interest only.
Ben Mandel 12:07
Correct. And that’s administered by the long term escrow company. Remember, the long term escrow company receives the installment note payment from the intermediary, and then makes the payment to the lender for the benefit of the seller. So there’s no administration obligation for the seller. And then there’s there is an annual $300 fee to the escrow company for their service.
J Darrin Gross 12:32
All right. And the interest only so will the the seller have a an ongoing mortgage essentially or is there is that pre funded or how’s that work?
Ben Mandel 12:45
Yeah, the the, they’re going to have a note receivable and a note payable and and the interest income on the note receivable and the interest expense on the note payable actually offset each other from a tax perspective.
J Darrin Gross 12:59
Got it. Is that something that the seller has to take care of? Or is that part of the process of the Qualified Intermediary in the lender structure that the the escrow company handle?
Ben Mandel 13:15
That’s all part of the process, the seller doesn’t have to take care of any of the administration of the transaction. The only thing that seller has to do one is received the proceeds from the loan and then invest how they choose when they choose. And they’ll need to use the 1099 and 1098 for their annual tax.
J Darrin Gross 13:34
Okay. So the 1099 to 1098 cents to offset the tax liability. All right.
Ben Mandel 13:40
J Darrin Gross 13:41
And so we get down the tracks we get to the 30 year mark, and the loan is due in full correct?
Ben Mandel 13:51
Yes. Correct. Both loans are doing okay.
J Darrin Gross 13:54
And interest as well? Or is the interest been paid all the way through? I mean, that’s, that’s been As we’ve been going, right, that’s the interest only loan. It’s just the principal we’ve got to pay back now. Correct?
Ben Mandel 14:05
J Darrin Gross 14:07
Gotcha. Gotcha. And the percentage of the interest is, what’s the percentage rate?
Ben Mandel 14:16
It varies from time to time, given the prevailing market rates. It’s essentially lately it’s been anywhere between five and 6%. But it’s not it doesn’t impact the seller at all because the the interest income and interest expense offset each other and they don’t, they don’t actually receive or pay the money. It’s all done by the escrow agent.
J Darrin Gross 14:41
All right, but that but at the on the front end, though, the seller is going to get the 93 and a half percent of whatever their their sale price was. reckoned take receipt of that because it’s alone. It’s not. It’s not the proceeds of the sale. And so now, they’re free to Go invest with whatever they want. But they they do have this note that comes up 30 years in the future and if they’re they’re alive to pay it, then they have to pay it. What it what happens if you pass before the 30 years around?
Ben Mandel 15:19
That actually is that is the planning risk. The there are several different methodologies that we help our sellers with, in conjunction with their financial advisors and professionals to plan for that event. Many many sellers, purchase insurance life insurance policy. Second died or survivorship policies typically, if some sellers will, will insure a spouse who is significantly younger rather than the older spouse to save money given that the older spouse would have a longer a shorter mortality. There’s a lot of ways to accomplish that. But in addition they don’t have to purchase insurance they could put a certain percentage of the money typically we will recommend the advisor utilize five to 6% of that 93 and a half percent and put it in a conservative interest bearing type account, municipal bonds treasuries whatever the case may be, that could be utilized to pay that tax when the owner if the sellers word of past there are a lot of different methodologies and there have been some
J Darrin Gross 16:56
All right. Okay, so We were talking about the the 30 years in the U turn with the 5% or take take a percentage amount and put that in a interest bearing account or something to kind of prepare for that. Okay.
Ben Mandel 17:21
And there’s also another another aspect of this process is the seller does not have to actually wait 30 years to pay the tax. If at any time for tax planning reasons, reasons, it benefits the seller to advance a portion of the principal or all of the principal, they can do that in any time during the 30 years to take advantage of whatever advantageous tax planning may occur. For instance, you know, a times some of our sellers or investors experience a large loss in a given year, well, they can advance a part of the principles To be offset by the loss, thus not paying any tax on that portion of the principal, there could be a significant tax increase in a given year that creates concern for the seller, and they would rather pay the taxes before that tax increase goes into effect, they can advance the entire amount and pay the taxes. Prior to that tax increase going into effect, we do caution our sellers don’t understand the huge advantage of this process is the opportunity regained over the 30 year period with their money to earn money, so it would have to be a large tax increase or have a short duration left on the 30 years to really make sense to advance the entire amount. They could advance a portion sure and pay the taxes on a portion of it if they were concerned about tax.
J Darrin Gross 18:52
So the the the two elements that are in play though is the taxes still do it just you’ve deferred it till this the end of this receipt of the the money, which is basically the loan and then also you’ve got the loan to to be repaid. If I’m understanding right.
Ben Mandel 19:13
correct the loan will be repaid by the proceeds from the installment note. So it’s not ever a burden to the individual seller because there’s an offsetting note that will pay.
J Darrin Gross 19:28
Ben Mandel 19:31
Limited recourse. The loan is a financial based loan, and the lender doesn’t hold the seller in any type of recourse if the loan were to default. For instance, if the Qualified Intermediary absconded or went bankrupt, the individual wouldn’t have to pay back that loan because of that reason. So they’ve got very limited, almost no recourse on that one.
J Darrin Gross 20:00
So as I’m thinking through this, I’m assuming that the the the ideal prospect is somebody that’s owned a property for a very long time that has a substantial gain, probably has substantial depreciation recapture. Is there kind of a sweet spot where you’ve seen that dollar amount make more sense where majority of your clients take advantage of this.
Ben Mandel 20:30
Typically, you’re looking at somebody having held the property for seven plus years. If it’s, if it’s sooner than seven years, unless there’s been some unbelievable appreciation. If it’s sooner than seven years, when you look at the fees of the transaction, it kind of limits the benefit from from doing
J Darrin Gross 20:49
Is there any kind of $1 amount where you see kind of a mean seven and a half years is one thing for kind of the depreciation recapture. I would think but as far as dollar amount or desert? Can you point to that or is there a threshold?
Ben Mandel 21:08
The only the only impact $1 amount has in our processes, we have a minimum transaction size of $500,000. But really the dollar amount has to if you if you analyze the sale and analyze the tax and look at the cost of the transaction, it has to make enough sense that there’s a big enough spread between the cost and the tax, that it makes sense to take the cash and reinvest and you regain the opportunity. Basically, you don’t you don’t have to pay the tax. So you get to hold it and make money on the tax rather than then just paying the tax when when you sell the property. There really isn’t it just every deal you have to analyze and take a look at and if it’s something that the seller is interested in Looking at, well, then we go through a process of analyzing Well, what happens if you pay the tax? What happens if you utilize our process? And even you know, some people aren’t convinced they don’t want to do a 1031 exchange. So we look at what happens if you do a 1031 exchange, and and we’re 100% supportive of them doing the best thing for them. I mean, I look I, we offer this process, not because we feel like it makes sense for everybody. And likewise, we also offer this process because we understand that the 1031 exchange doesn’t make sense for everybody, nor does a deferred sales trust which is another methodology to defer the tax there you know, as many different options as you can have for the investor, then then the best service that the investor invent or the best serve the investor is in terms of being able to identify what the best solution for them.
J Darrin Gross 22:54
Got it. So the real benefits from understanding this is that you have access To the the proceeds. And you can go invest as you as you wish. You You don’t know the tax today, but the tax is still it’s owed, but just you deferred it for, presumably 30 years or shorter if you choose. But it gives you basically the flexibility to to do other things. Is that my understanding that pretty much you’re
Ben Mandel 23:26
correct, it’s it’s the biggest issue with our process over the 1031 or the deferred sales trust as it gives you complete control over how you utilize the process.
J Darrin Gross 23:37
Gotcha. Ben, if we could, I’d like to shift gears here for a second. As I mentioned to you before we get started by damn an insurance broker. And as an insurance broker, I work with clients to assess risk and determine what to do with risk and we typically look at one of three different strategies when we’re trying to manage risk, and the first question we ask is, can we avoid the risk? If that’s not a, an option, and perhaps we can minimize the risk. And if we can neither avoid or minimize the risk, then we look to see if we can transfer the risk. And that’s essentially what an insurance policy is. And I’ve been asking my guests and I’d like to ask you, if you’re willing, if you can identify what what you see is the biggest risk. And just again, for clarification, I’m not necessarily looking for an insurance related answer If your answer is that. That’s great. But again, if you’re willing, Ben Mandel, what is the BIGGEST RISK?
Ben Mandel 24:55
Well, the biggest risk actually has two cards. Initially, the biggest one Risk is, as compared to the 1031 exchange, you, you will end up having to pay the tax at some point in the 1031. Exchange if you hold the property until you pass there’s no tax ever pay. So that’s that’s part A of the biggest risk. Part B of the biggest risk is, if you were to pass prior to the note being or the time period being completed on the transaction, then the heirs would have to choose whether or not they wanted to actually leave this open in the estate of the decedent or if they wanted to pay the tax early. We never suggest leaving it open in the state of Tennessee. The idea with estates usually is that you want to close them as quickly as possible. So those are the two biggest risks that last or risk we utilize, or we recommend to the sellers advisor. If they consider utilizing a survivorship insurance policy to transfer that risk of pre deceased in the 30 years, and having that benefit available to the heirs so that they could choose to just pay the tax when the individuals passed away. Otherwise, the biggest risk is if the if the individuals do not pass, there has to be some sort of plan that would allow them to pay that tax in 30 years. Theoretically, if you invest your money and you do well, you’ll have plenty of money to pay the tax. But what we suggest to the advisors in the event that they do outlive the 30 year period, that they set aside a certain percentage small percentage of the asset or the dollars that they receive into a conservative interest paying account, treasury bonds, municipal bonds, that would help to defer or or assist in paying that tax when it comes to you in 30 years.
J Darrin Gross 27:05
Got it. Got it. I just want to ask you, are your services are you able to take care of customers? Is there a limitation as to where somebody has to be located? Are you able to work nationwide?
Ben Mandel 27:22
Any any, any state in our country can utilize this process. Now, there are some states it’s more beneficial than others. For instance, California, when you look at the taxes that are paid on an appreciated asset, totals approximately 37% of the gain is paid in tax when you consider all of the state and federal taxes. And if you look at a state, such as Texas where I am or Florida, or any state that doesn’t have any state capital gains, if all you have to pay is the federal capital gain, then there’s no not as big of an impact as there is in a state that has a capital gains tax on the sale of an asset. That doesn’t mean that it’s not beneficial. And it can be very beneficial if there’s a large gain. But the tax isn’t as large obviously in states that don’t have state tax.
J Darrin Gross 28:20
Got it. Got it. Well, this has been enlightening Ben, I appreciated you taking us through this. Where can listeners go if they’d like to learn more or connect with you?
Ben Mandel 28:34
They can, they can call me at my on my cell phone number is the best way to call me and that that is area code 210-387-9728. Obviously, since that is my cell phone number. They can also text me if they have any questions, or would like to communicate with me about how the process works or how it might better To fit them. They also can email me My email address is email@example.com. Those would be the best ways to contact me. If they would like to get information on the process itself, they can go to my intermediaries website, which is initial SCROWCollateral.coms.
J Darrin Gross 29:36
Ben Mandel 29:37
I said CR o CR, O w, I’m sorry. collateral com.
J Darrin Gross 29:42
Got it. Got it. Then, again, I can’t say thanks enough for taking the time. I’ve enjoyed it. and learned a lot. And I hope we can do it again soon.
Ben Mandel 29:54
Absolutely. I appreciate it. Thank you very much for having me.
J Darrin Gross 29:57
All right. For our listeners. If you like this This episode Don’t forget to like, share and subscribe. Remember, the more you know, the more you grow. That’s all we’ve got this week. Until next time, thanks for listening to Commercial Real Estate Pro Networks. CREPN Radio.
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