Brett is a real estate tax expert who is coming on the show today to help us with any tax problems we may have. Joe and Brett will get into the details of real estate taxes, and we’ll hear some stories of investors saving money on taxes with Brett’s help. If you enjoyed today’s episode remember to subscribe in iTunes and leave us a review!
Best Ever Tweet:
“Find somebody who is a specialist in that area and diversify” – Brett Swarts
Brett Swarts Real Estate Background:
- President of Capital Gains Tax Solutions, LLC
- Provides trustee services which helps real estate and business owners gain tax deferral, freedom, liquidity and diversification with their funds so they can create and preserve more wealth
- Based in Sacramento, CA
- Say hi to him at capitalgainstaxsolutions
- Best Ever Book: Crucial Conversations
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Joe Fairless: Best Ever listeners, how are you doing? Welcome to the best real estate investing advice ever show. I’m Joe Fairless, and this is the world’s longest-running daily real estate investing podcast, where we only talk about the best advice ever, we don’t get into any of that fluffy stuff. With us today, Brett Swarts. How are you doing, Brett?
Brett Swarts: I’m doing well, Joe. Thanks for having me on the show.
Joe Fairless: Well, my pleasure, and looking forward to our conversation. A little bit about Brett – he’s the president of Capital Gains Tax Solutions. He provides trustee services which helps real estate and business owners gain tax deferral, freedom, liquidity and diversification with their funds, so they can create and preserve more wealth. Based in Sacramento, California.
With that being said, do you wanna give the Best Ever listeners a little bit more about your background and your current focus?
Brett Swarts: Yes. Thanks, Joe. I started out in real estate as a young child, with my dad, helping him build custom homes in Fremont, San Jose, Northern California area. Rentals have always been in my life. I studied business in college, went on to Marcus & Millichap as an internship, and was with them for five years as a commercial real estate broker, helping clients buy and sell apartment buildings mainly.
From there I went and kind of started my own two companies, Commercial Realty Apartment Advisors and Capital Gains Tax Solutions. That’s kind of the business background. I’m married, five kids, I played basketball in college, [unintelligible [00:02:32].03] in particular, and I love playing that as much as I can…
Joe Fairless: Marcus & Millichap real estate broker, and now you’re working with owners of properties to set up their business, so they can defer the capital gains… How did you make the conscious choice to transition?
Brett Swarts: At Marcus & Millichap at the time when I was first starting in 2006, I was still in college, but graduated in ’07, the market shifted quite a bit in ’08, and things changed… And the manager at the time in my Marcus & Millichap office in Sacramento – he brought in a gentleman to speak on the deferred sales trust as an alternative or a back-up plan for a failed 1031 exchange… And we were looking for ways to help clients solve these issues.
The biggest stat that he left with us at the time was there’s about – according to the American Bankers Association – 17 trillion dollars that will pass from one generation to the next in the next 20 years… And this is known as the baby boomers. It’s the largest wealth transfer in the history of the world, and 50% of America’s net worth is tied to high-end primary homes, commercial real estate, and also private equity or businesses.
So they’re faced with the [unintelligible [00:03:41].12] liability and looking for alternative ways to get out of real estate. So he approached us with that strategy, and I started to study it and look at it, and I obtained my series 22 and 63… But really, my approach, Joe, has always been to add value and find a solution for what my clients were looking for. And as the years passed by and the marketplace has really grown in appreciation, everything has kind of shifted from these baby boomers who don’t wanna be in debt, who are tired of the 1031 exchange, who don’t necessarily wanna overpay for a property in a highly appreciated marketplace…
So I launched a company in partnership with the Estate Planning Team to really focus on commercial real estate owners, syndicators, business brokers and high-end luxury real estate agents to help them grow their business. So it’s kind of a natural progression, if you will, from focusing just on the 1031 exchange, to now the deferred sales trust as another option.
Joe Fairless: Okay, so the deferred sales trust – I guess that’s the unique thing that you bring to the table from a consulting standpoint, and help set up… Is that correct?
Brett Swarts: Exactly.
Joe Fairless: Okay. And what exactly is that?
Brett Swarts: A deferred sales trust is just a manufactured installment sale, Joe. It’s like a seller carryback, except we’re using a third-party trust to buy your property. Let’s say you have a deal you’re selling for ten million – they’re gonna give you a zero down payment in exchange for a note… But immediately we’re gonna sell it to the cash buyer that’s already lined up for ten million, and therefore we can defer all the tax, because you haven’t received any actual or constructive receipt… So it’s just a manufactured installment sale; it’s tied to IRC 453, which is a 90+ year old tax law.
We’ve been doing it – we collectively, and there’s thousands of professionals now across the U.S, financial advisors, CPAs, tax attorneys, QI companies, syndicators who use our strategy. A 23-year track record, over thousands of trusts have been closed, 14 no-change IRS audits… So it’s just an installment sale, but it’s unique in how we do it.
Joe Fairless: Okay. So will you give maybe an example of a client of yours that you can share, that they did, and then just walk us through some numbers and the process?
Brett Swarts: Of course. A recent one, just a couple weeks ago, a gentleman named Peter – he’s out of Marin, California, long-term commercial real estate investor, mostly with multifamily, but he’s also a residential broker himself – so he sold an 18-unit apartment complex in Sacramento; so he’s driving up from the Bay Area, he’s knocking on doors, he’s collecting rents… It’s kind of a tough neighborhood he’s going into Sacramento… So he was stuck with a property that he didn’t wanna own, but he also didn’t wanna 1031 exchange. And the way he put it was “I’d rather have 18 problems. I don’t want 36 problems. I actually just kind of wanna retire. I’m older now, and I wanna get out of debt, and I wanna diversify… And I actually want a passive income stream, but I don’t wanna have to do it myself.”
The property itself is only about 18 units, so it’s hard to hire property management to get scale and make sense of the numbers there… So he learned about the deferred sales trust and he liked the fact that he could sell it and he could pay up all of his debt, so now he’s debt-free… He had about $500,000 of debt.
Joe Fairless: On the property, or separate from the property?
Brett Swarts: On the property, yeah.
Joe Fairless: Okay, alright.
Brett Swarts: So he was selling for about 1.8, and he had about 500k in debt… So he was gonna net about 1.3 into the trust.
Joe Fairless: Okay.
Brett Swarts: He had a basis that was pretty low too, because he had done exchanges into this property… So he had another 500k in liability for tax liability. That’s state, federal, Obamacare; it’s about 37% if you add that up in California, plus the depreciation recapture, which can be as high as 40% or so… Or even higher.
Joe Fairless: 40% on top of the 500k, or in total?
Brett Swarts: Yeah, so he was faced with two things – he had debt of 500k, and then he had a tax liability of 500k… So he felt completely trapped. He goes “I have to do a 1031 or something else, because by the time I pay off my debt and pay off the capital gains tax I’m just gonna get wiped out. It makes zero sense. But again, I don’t wanna have 36 problems. I already have 18 problems. I don’t know what to do.”
Joe Fairless: Right.
Brett Swarts: That’s where a lot of my clients have been over the years – they feel trapped between over-paying for property, taking on more debt, chasing deals that otherwise they wouldn’t pay for if it wasn’t for their 37% to 50% of their gain being wiped out by the capital gains tax… So enter the deferred sales trust – he was able to sell, put 1.3 million into the trust, become debt-free, defer that $500,000 in tax as well that he owed… And now he’s invested in stocks, bonds, mutual funds of his choosing… But his real passion is to put it into commercial real estate syndication deals with different operators across the U.S, where he can diversify within that portfolio about 80% of the funds.
So it solved his “Hey, I don’t like the stock market.” It solved his “I can still be in commercial real estate”, and the biggest one is he can buy whenever he wants to. He doesn’t have to buy tomorrow or day 180. He can wait on the sidelines until deals make sense.
Joe Fairless: Okay. And who’s paying the 1.8 for the property that’s participating in the deferred sales trust?
Brett Swarts: Just a buyer. Especially in California and Sacramento – it’s one of the hottest multifamily markets in the nation, and there’s tons of 1031 buyers and tons of buyers that wanna pay a price for the property.
I think the deal traded around about a 6,25% cap. It was a C deal, C- location… So yeah, just a cash buyer that’s lined up. It can have a lender… They take title the same way they would have, as if Peter was gonna do a 1031 or a deferred sales trust.
Joe Fairless: Got it. So from the buyer’s standpoint it’s not that different from buying it if they were doing a 1031.
Brett Swarts: Correct. It’s like a simultaneous close. It’s actually an assignment of sale. So what Peter did is he just put language into the document that states that he has the right to a deferred sales trust or a 1031, and no additional cost to the buyer. And he did consider that, by the way, going for a 1031 and looking for a deal… Because the deferred sales trust is actually a back-up plan for a failed 1031. So it actually empowers people too to go out there and search for a deal, and if they can’t find it, they have a back-up plan. And it also doesn’t take up one of their positions either for the exchange rules.
Joe Fairless: Okay, so you have to have the money with an intermediary during the process when you’re looking for a 1031 exchange… So as long as you have that with the third-party, then you can still do the deferred sales trust if your 1031 falls through?
Brett Swarts: You got it. It’s a constructive or actual receipt. So the way a 1031 works, Joe, as you probably know and your listeners know, is instead of having the funds sent to (say) Joe from escrow, we wanna send it to a QI company who holds the money to maintain non-constructive receipt for you… And then at that point you can move the funds to another property and perfect the exchange. The same concept is true here – instead of the funds being sent directly to Peter or Joe, they’re gonna be sent to the trust, which is gonna maintain non-constructive receipt.
Joe Fairless: Got it, okay. What are some questions investors have about this, that are common, that you address?
Brett Swarts: The first one is “How do we know it’s legal? It sounds too good to be true.” Those are the two biggest things. The first thing we would say – it’s a 90-year-old tax law; thousands of trusts have been closed. We have thousands of business professionals… And it’s just an installment sale; we’re just creative on how we use it.
The next one is “Where are the funds held?” Well, the funds are held at Bank of New York Mellon, Charles Schwab, TD Ameritrade… You can hire your own financial advisor or you can use one of our professionals that we work with across the U.S. to manage the money. They can put it into stocks, bonds, mutual funds of your choosing; very conservative allocations.
My favorite part is they say “Well, can I go back into real estate?” and the answer is “Absolutely.” You can go in tomorrow, or whenever you want to, and then you can diversify it. So those are the main ones… But we encourage everybody to bring in their trusted advisors, Joe. We recognize that this is a new concept for people, so we actually say “Hey, don’t just trust what we’re saying; bring in your brain surgeons.” And who are the brain surgeons? Those are the CPAs and tax attorneys that you trust. Have them speak with our CPAs and tax attorneys before moving forward.
My role as a third-party trustee – I can’t ever move the funds; the funds only ever move with the client’s signature. The client has 24/7 access to view the funds. But my role is to educate and be the offensive coordinator in this scenario, where I’m working with a commercial real estate broker, the financial advisor, the CPA, the tax attorney, and the client. So we all work together as a team to make this transaction work.
Joe Fairless: And what are some things that you pay attention to within your role of the transaction?
Brett Swarts: My role is just to give them all the options. By the way, my company is Capital Gains Tax Solutions, plural, so I like to present the 1031 exchange, the pros and the cons, and then the deferred sales trust, the Delaware statutory trust, the charitable… And really just empower the client with the information and with the tool.
I liken it to this, Joe – imagine it was 25 years ago and you’re just learning about the 1031 exchange for the first time. Before you knew about it, you were just buying and selling properties and paying the tax. Then all of a sudden somebody empowered you with the strategy, and then once you understood it, you were able to create and preserve more wealth… So I really see my role as that – just empowering and educating, kind of being the guide for the client, so that they can create and preserve more wealth with the strategy. Hopefully that answers the question.
Joe Fairless: Got it, okay. And with the different options that someone has – let’s go with the deferred sales trust, to be specific… How are you compensated?
Brett Swarts: By the way, it works for a business, a high-end primary home, commercial real estate, collectibles… Anything you can think of, the deferred sales trust works for, whereas the 1031 only works for investment property mainly. So when they sell and the proceeds go into the trust, we get a recurring fee. So a first fee is about 50 basis points on the initial amount, and then once a year we get paid again, as long as the funds are in the trust. Most of our trusts go for ten years, but at the end of ten years you can renew for another ten, and then renew for another ten, and just keep going for as long as you want. Then you can pass it on to your kids.
Most of our notes earn 8%, and after fees they net about 6.5%, which is where the other fee comes in – that’s to your financial advisor. They charge somewhere between 50 basis points and 100 basis points, which is 0.5% to 1%… So just depending on where and how the funds are invested.
The last fee is to the tax attorneys. It’s 1.5% on the first million and 1.25% on anything above that. That includes audit defense for the life of the trust… But what we’re really focused on is what is your actual tax liability? So if you’re selling a ten million dollar deal, Joe, and you have a four million dollar tax liability (let’s imagine you had a zero basis), we’re gonna focus on that four million, and that’s a big number. We would say that that’s substantial; you’re gonna wanna do a 1031, or a Delaware, or a deferred sales trust, or maybe a mixture of all three, depending on your scenario… So we’re really gonna dissect what’s going on. Do you have a mortgage over basis? Do you have some liquidity needs? Do you wanna get rid of the [unintelligible [00:14:48].08] liability? Do you want to stay in real estate with local operators that you trust and know?
So we’re really gonna ask a series of questions to decipher where the risk tolerance is, and also what their outlook is, and how comfortable they are with different asset classes… And then from there recommend one, two or three strategies, or maybe just one strategy.
Joe Fairless: What’s a potential client that’s come to you and you just couldn’t help them for X, Y, Z reason? Can you just talk about that?
Brett Swarts: Yeah, so if you come to me, Joe, and you’re selling your business, and the buyer has removed all contingencies, it’s too late for us. We need to be able to be there before he does that. Now, commercial real estate is unique. Even if they remove all contingencies, we would just tell you to send it to a 1031 company, and that 1031 company at that point on day 46, we can help you, up until day 181. But if you take constructive receipt or actual receipt, it’s too late. So the next thing is working with a 1031 company, which will give you both options.
There’s certain 1031 companies who haven’t heard about this. The big banks sometimes don’t move outside of their lane… So we’re still educating a lot of different QI companies. So I would just recommend you make sure you have the language in your exchange agreement, because if you don’t, they may not cooperate and they may just send you the check from the QI company and then you’re gonna owe the tax. Those are the two main ones.
The other one has to do with just lower tax liability. It’s just a small amount. If you’re selling a 10 million dollar deal, Joe, and you only owe 50k or 100k in tax, we’re gonna tell you “Just pay the tax.” Take the 9.9 and go look for a deal for when it makes sense. So we’re gonna try to make a holistic approach to financial — within the actual strategy there’s some rules we have to follow.
Joe Fairless: I think you mentioned this tax code for deferred sales trust has been around for 90 years… Did I hear you correctly?
Brett Swarts: Correct. IRC 453, which is just a seller carryback… That’s the foundation of the tax code.
Joe Fairless: So what happened recently that brought this to light, that now it’s being discussed and you’re working with clients on it?
Brett Swarts: Yeah… Even a better question would be “How have you survived the IRS audits?”, which I think will answer the question you’re asking… So there’s been 14 no-change IRS audits; the biggest one was for over a 100 million dollar deal, and absolutely no issues whatsoever. These are random audits for just clients who are high net worth and they happen to find the deferred sales trust and look at it.
The last audit was a formal audit of the structure itself, of the law firm who created it, and the co-founder of the deferred sales trust with the estate planning team… And the first hour of the audit they said “Look, this is just an installment sale. You guys are being creative on how you’re applying the law, by using this third-party trust, who’s in it for a business purpose, who’s an unrelated party, and who can make a profit”, which those things are all true. As long as you’re following those rules, it works. So that’s the best answer I have. We’ve been able to do it thousands of times, and it’s been reviewed by national law firms. It’s not until you meet somebody who’s gonna educate you on the strategy that you’re gonna hear about it.
We also don’t necessarily mass-market it to everybody. I’m only one of 13 exclusive trustees across the U.S, Joe, so we’re very protective of the strategy… Although we’ll share it with a non-disclosure agreement, no problem… But we don’t want it getting into the wrong hands, where somebody might abuse the structure and we lose it for everybody… So we’re very particular about who and where they see the secret sauce, if you will.
Joe Fairless: Okay… And I guess because I didn’t sign an NDA or anything to have a conversation, you’re publicly talking about this —
Brett Swarts: Oh, this is fine. All the stuff we’re talking about here is fine, yeah.
Joe Fairless: So what aspect is more in the NDA component of the conversation?
Brett Swarts: It’s the actual execution of this. I mentioned a couple of things: business purpose, third-party unrelated trustee… And then it’s also the ability to keep the funds safe, liquid, with an investment advisor. Those are the main areas, if I’m somebody approaching this for the first time, that I’d wanna understand. And then the brain surgeon is the law firm who created this; they can talk about these things. A lot of the times they don’t even really come up; people just say “Oh, it’s an installment sale, it works…” So hopefully that answers the question without giving too much away.
Joe Fairless: Based on your experience in the real estate industry, what’s your best advice ever for real estate investors?
Brett Swarts: Buy at optimal timing. Buy when deals make sense. We make our money on the buy side; we make money when we can find value-add, forced appreciation deals that make sense. And you may wanna consider diversifying outside of your single product type, and your single location, and find somebody who’s an operator, who’s a syndicator, who’s a specialist in that area, and diversify outside. The deferred sales trust allows you to do that.
Don’t overpay just because you only know the 1031 exchange. Get out of debt now and take on smart debt when the market is low, when you can buy properties at a discount. Risky debt stays in and keeps ride up, but don’t go into dumb debt when you overpay for properties just because you’re deferring the tax through a 1031 exchange. Make sure the fundamentals of the real estate make sense; if they don’t, figure out a way, or in a different location, with a different operator, and a different product type that does.
Joe Fairless: We’re gonna do a lightning round. Are you ready for the Best Ever Lightning Round?
Brett Swarts: Yeah, let’s go.
Joe Fairless: Alright, let’s do it. First, a quick word from our Best Ever partners.
Joe Fairless: Best ever book you’ve recently read?
Brett Swarts: Best ever book I recently read… Crucial Conversations.
Joe Fairless: I love that book. What’s a mistake you’ve made on a transaction?
Brett Swarts: A mistake I’ve made on a transaction… Not saying yes to the client who wanted to bring in a partner on a deal, in the 12th hour; I should have just said “Yes. Whatever you wanna do, let’s work together.” I had too much pride and wanted to do it myself.
Joe Fairless: Best ever deal you’ve done?
Brett Swarts: Best ever deal I’ve done… Let’s see. We’ll talk about brokerage – it was an 8.2 million dollar value-add multifamily here in Sacramento, representing both sides, and it was a win/win because there was still some meat on the bone for the buyer, who was my client, and the seller had an up-leg lined up… So he bought it for 8.2, and now it’s worth 13 million and it’s only been a year and a half.
Joe Fairless: How can the Best Ever listeners learn more about what you’re doing?
Brett Swarts: Go to CapitalGainsTaxSolutions.com, or search me on YouTube, Bigger Pockets, LinkedIn… Connect with us. We have a deferred sales trust calculator; you can put it in there and it’s totally free; it will give you a side-by-side comparison. And/or schedule a one-on-one call with me and I’ll walk you through our strategy more.
Joe Fairless: Brett, thanks so much for being on the show, talking about deferred sales trusts, as well as the approach and a couple use cases. I hope you have a best ever day, and we’ll talk to you again soon.
Brett Swarts: Thanks, Joe.