William “Bill” L. Exeter is a highly respected expert in the financial services industry with over 40 years of experience, specializing in real estate tax strategies, including 1031 Exchanges, Self-Directed IRAs, and Title Holding Trusts. As the CEO, Chief Trust Officer, CFO, and Treasurer of The Exeter Group of Companies, Bill oversees operations for Exeter 1031 Exchange Services, LLC, Exeter Trust Company, and Exeter Asset Services Corporation.
A pioneer in the 1031 Exchange industry, Bill has administered over 125,000 transactions and is a founding member of the Federation of Exchange Accommodators. He is a sought-after speaker, educator, and expert witness, sharing his knowledge on investment strategies and alternative assets through seminars, podcasts, and media appearances.
Bill holds a Bachelor of Science degree in Accounting from California State University, Los Angeles, and the Certified Securities Operations Professional (CSOP) designation from the Cannon Financial Institute. He is based in San Diego, California.
In this episode:
- Key differences between Reverse Exchange vs. Forward Exchange
- Improvement (Build) Exchange Explained: Deadlines, complexities, and planning essentials.
- The role of Exchange LLCs and fund control in 1031 exchanges.
- Self-Directed IRAs and 1031 Exchanges
- Step-Up in Cost Basis: How it works and its impact on 1031 exchanges.
- Common Mistakes in 1031 Exchanges: Top pitfalls to avoid for successful transactions.
Episode:
Narrator Welcome to The Norris Group real estate podcast, a show committed to bringing you insights from thought leaders shaping the real estate industry. In each episode, we’ll dive into conversations with industry experts and local insiders, all aimed at helping you thrive in an ever-changing real estate market. continuing the legacy that Bruce Norris created, sharing valuable knowledge, and empowering you on your real estate journey. Whether you’re a seasoned pro or a newcomer, this is your go-to source for insider tips, market trends and success strategies. Here’s your host, Craig Evans.
Joey Romero Hey, thank you for joining us again for part two of our interview with Bill Exeter of Exeter 1031 exchange Services LLC. Let’s get to it. Okay, so let’s get into what’s the reverse exchange and what’s the biggest difference between this and the forward exchange?
Bill Exeter Good question. Maybe I’ll start off with the risk of a forward exchange. With a forward exchange, you are selling first you trigger your gain, and as long as you can identify within the 45 days and then actually acquire the property, you defer it so it’s not taxable. But if something happens and you can’t identify or you can’t acquire the property, then the forward exchange becomes a taxable sale, and there’s no way to go back and fix that. So that’s really the risk on a forward exchange. But the forward exchanges are much simpler, much more straightforward, etc. With a reverse exchange, it allows you to go out and spend all the time you want to find the new property. You buy the property so you go into contract, you can actually close on the purchase of your new property first, then you’ve got the 180 days to sell your current property. Sounds easy, but they’re a lot more complicated. There’s more costs involved. So you know one way to explain it is a pure reverse exchange, which does not exist. But a pure reverse exchange would mean that the client could go out, buy the new property, take title to it, own both properties at the same time, and then sell their current property within six months. And the IRS doesn’t permit that, so they’ve set up what they call a parking arrangement. So in most cases, the new property you’re going to buy, we have to acquire and hold, or what the IRS calls chart legal title to the property. So the only thing that occurs up front in that structure is we, we park title to the property. The the 1031 exchange hasn’t even entered the picture yet, and then, let’s say, a few months down the road, you sell your current asset, and at that point, it’s really a concurrent exchange. You sell, you close on the sale, you convey title to the buyer of your property, and then we transfer the property to you that we’ve been holding on your behalf. So it’s really kind of a back end or exchange last as they call it, where we swap the properties at the back end. So it takes a lot of the risk out of the market because you’ve closed on your new property first. It’s just more complicated. Traditional lenders don’t like the fact that we’re holding title to the property. So if you could do an all cash purchase, it worked great. If there’s a lender involved, we have to kind of go through the process to see if the lender will allow it.
Joey Romero Now, is there a risk of accidentally triggering a reverse exchange?
Bill Exeter Good question. I guess the only risk is, we’ve had people who haven’t talked to anyone about the reverse exchange. They maybe read up on it in the internet, and they don’t realize that they have to do this parking arrangement. So we’ll get phone calls all the time where they say, Well, I bought the property. Now I want to do a reverse exchange. And if they got title to the property, it’s too late to do the reverse. So they, I guess they didn’t really accidentally the way, you still have to plan it. You have to plan it. Everything has to be set in place before closing. So, yeah, it wouldn’t be accidentally triggered, but they could accidentally buy it, not realizing they have to carpet with us. So that’s really the risk that we see quite a bit.
Joey Romero Okay. And then the third one that we’re really familiar with, especially here at The Norris Group with our boot camp, is the improvement exchange, or the build exchange. Is that the most complicated of all the processes?
Bill Exeter Definitely most complicated of all the processes in the improvement exchange can be done either with a forward exchange structure, which I think most of them are done that way, but it could also be done with a reverse 1031, exchange structure. I’ll use the forward because that’s what most people do. So you’re selling your current property. First the funds come to us at closing, then you identify the property that you want to buy and build on. So you’re really identifying, in most cases, dirt, and then you’re identifying also what you intend to complete or build out on the property. And then it’s just like a reverse structure we take title to the property you want to build on. So it’s the same parking arrangement, and then they have the rest of the 180 day period to actually complete the capital improvements. And the neat thing about the Florida boot camps with you guys is, of course, everything’s kind of lined up in advance. So really, you sell usually day one, you’re already starting the construction and build out. So you’ve got the full 180 days. You know, a lot of folks who are doing it on their own, they close, we’re holding the cash, and they identify right around the 45th day. So they’ve already lost a month and a half, and to get permits in another, you know, four and a half months is almost impossible.
Joey Romero Yeah. So you just said something that it can a build exchange could be done in a reverse exchange. So how, when does that start the 180 days like, because you know when you’re buying something that’s already existing, okay, that’s when you bought it, you know. Now the build cycle, you know, if you look at the last three years, that has fluctuated from five months to 18 months. Some people even two years to complete a build. So how does that work?
Bill Exeter Yeah, good question. It’s just like a reverse exchange. So we would set up the reverse. They would go under contract, etc. We would be assigned into the contract. So we step into these shoes as the buyer when the closing occurs. We actually take legal title to the property or park title to it just like the regular reverse. Then the only difference is, once we take title, that’s when the 180 day period starts. So at that point they could start doing the build out right away, and the sale of their current property maybe four or five months down the road. And as long as we can wrap all that up within that six month period, then it would certainly qualify. The beauty again, is you buy first, you take the risk out of you know whether or not you can find replacement property. There’s just more complexities to it. And if there’s a traditional lender involved, they probably won’t touch it. Now, construction financing, they usually will take a look at it. So it certainly a possibility.
Joey Romero Now, do all the same deadlines apply? 180, 45?
Bill Exeter Typically, yes, if you want to do a safe harbor, which means you’re following the revenue ruling that the IRS came out with, or revenue procedure, then you would have the same 45 days. In this case, 45 days to identify what you’re going to sell because you’ve already bought, and then you’ve got 180 days to do all the purchase and then all the build out. There’s one case where they structured this as a 24 month process, and they finished it in 17 months. The IRS disallowed the transaction. It’s the Bartel versus Commissioner case. They took it at court and they won. So we have a case on the books now that says you can do that. However, the IRS has also come out and said, Yep, we still hate it, so if you do it and you get audited, you’re probably going to be doing that.
Joey Romero So, in that case, if you did it, knowing there’s precedent, there’s a chance that you still disqualified, but then you’d probably have to go to court to try to get it.
Bill Exeter It’s exactly the same fact pattern, you might get lucky and prevail. If it’s you know, everybody’s case though, or transaction is always a little different. So you just never know. It’s certainly not for the faint of heart.
Joey Romero Now, one of the things that happens in these these build exchanges, is you create exchange LLCs. Can you tell us a little bit about that?
Bill Exeter Yes. So with the improvements, or even in also the reverses, with that parking arrangement, there’s a number of ways of doing it, one way which we do not recommend, but one way is the exchange company may have one entity, like a C corporation, and they’ll use that entity to acquire and hold all client properties. Well, that could be a lot of properties in the same year, and if any of those properties have any kind of an issue, liens, judgments, toxic waste issue, whatever it might be, it could affect the entity, and it could affect all the properties in the entity. So we always set up a brand new LLC for every single client. We never reuse the LLC, and that way the LLC is acquiring and holding legal title to the property. It’s a brand new LLC so the client doesn’t have to worry about any other client or any other real estate. It protects the client from liability. It also protects us from liability. So that entity is owned by us during that 180 day window. And then with improvement exchanges, it’s almost always on the 180th day, we transfer that LLC to the client. They become the owner, signer, etc, and that’s how they get ownership of the property.
Joey Romero Now, what if, let’s say I want to, I end up like, you know what? This is going, great. I want to do another exchange. Can I use the same LLC to do a back to back exchange?
Bill Exeter Yes, if it’s the same client, we could certainly do that. Then we’d have to transfer the property out by deed, rather than assigning the LLC. So it is possible. Well, in most cases, because of the deed and issues like that, we usually will transfer the LLC and then do a brand new LLC for the next transaction, but it is possible to use the same one.
Joey Romero On build exchange. Do you require funds control, or is there even a requirement for funds control?
Bill Exeter There’s no requirement for funds control. So it really depends on the sponsor, excuse me, in the client and what they want. The fund control certainly protects both the sponsor and the client to make sure that everything is being paid, you know, liens are being released, etc. There’s no, you know, in some cases, there’s all sorts of history where there’s been developers or whatever, who’ve run off with money. You’ve heard all these stories. So fund control protects all the parties. So, it’s a great way to go, just to protect yourself, but there’s no requirement to do so.
Joey Romero So what happens if I’m doing a build exchange, and we get hit with delays, and I don’t, you know, I finish in nine months, instead of, you know, the 180 days.
Bill Exeter Good question. If it’s, you know, if it’s going to go for more than 180 days, then what we’ll do is, on the 180 day, we’ll wrap up the improvement exchange will transfer that LLC to the client, so they become the owner, and only the improvements that have both been paid for and completed will qualify as part of their reinvestment. So that might mean that they’ve only gotten 60, 70, 80% of their improvements completed. So only those completed would count toward their reinvestment values. That might mean that they’re exchanging short so they might have to some tax consequences. In a lot of cases, clients are trading up in value. So if that’s the case, it might still be okay. It’ll just depend on the numbers.
Joey Romero So what happens on that 20%? Well, that’s what we call it’s called boot?
Bill Exeter It’s called boot, yep, funny name for that, isn’t it? So yes, boot, if the 20% that’s not completed means that they’ve traded down in value, then it’s taxable. Boot, it doesn’t hurt the rest of the exchange, but they will pay tax on the portion that was not reinvested.
Joey Romero Now, I can’t just like, buy, like stuff and have it sit in the garage, right? You’re saying it has to be installed and completed, right?
Bill Exeter Yes. A perfect example would be a client that says, Okay, could you cut a check for $100,000 to pay the lumber yard, and the lumber yard dumps the lumber on the property. At that point, it still doesn’t count, because it’s not real estate, it’s just personal property, meaning non real estate, it’s just sitting on the dirt. But once you put it together, it becomes a frame and you attach it to the foundation. Now it’s part of the real estate, it would count.
Joey Romero Okay. So one of, one of the things too, is that complicates. Thing is when there’s a mortgage or leverage on the relinquished property. Now, can you talk about what has to happen on the other side of that?
Bill Exeter Sure. So as an example, let’s say you’re selling property today, and you’ve got a million dollar sale price, you’ve got $400,000 of equity, you’ve got $600,000 of debt or bank financing. If you sell that, the requirement, as we talked about before, is you, after closing costs, you’re going to have a net sale price of about 950-ish or so. So that’s what you have to reinvest. So you’re typically going to go over and if it’s a straight across the board exchange. You’re not exchanging up in value. You’re probably going to buy something for about a million dollars. In that case, the $400,000 of equity moves over, so you reinvest your equity on the new property, and the difference will be new debt of $600,000 so most people get another loan for the 600,000 you could replace that loan with cash. So some people say, I just don’t want any more mortgage, and I’m going to put $600,000 out of my pocket into closing. And that certainly qualifies, because you’ve still reinvested the full million, and you’ve replaced the debt with cash out of your pocket. So that would count too.
Joey Romero And then you said that the clearly that the full amount, because you can’t just say, ‘Well, I’m just gonna buy a house with the equity.’ You’re still gonna have to pay taxes on on the side that paid off the mortgage, right?
Bill Exeter Absolutely. So in that example, if they bought a house for 400,000 they put the 400,000 of equity there, they’ve actually traded down by 600,000 that’s taxable, and if they don’t prorate your cost basis, so that 600,000 would be 100% taxable. In that example, it probably would trigger the entire amount of taxable gain, unless they’ve got a green and low cost basis.
Joey Romero Wow. So how often do these 1030, ones get disqualified, and what triggers audits?
Bill Exeter Good question. You know, most of the audit usually, when there’s an audit, we get a notification, because they go, I need documents. I can’t find my documents. And so we don’t see very many audits. You know, contrary to what people say out there, the audit ratio is fairly low for these things. You know, nationwide, all tax returns, the last statistic I saw is total audits were like .6 or .7% of all tax returns. So audits are very low anyways. 1031, I would guess, are even lower, unless you’re in states like California, that California targets 1031 exchanges. So it’s probably higher in California, but it’s a very low audit risk there. Most of the ones I’ve been involved with, too, weren’t necessarily triggered because of the 1031 exchange. Maybe they had a 1099 and they didn’t report it and it didn’t match up on the IRS computer system or something like that. So it gets kicked out for an audit. They audit the entire return. California does tend to pull returns for an audit because of the 1031 exchange, but usually it’s larger transactions. You know, they never tell you what the audit threshold is. I think it’s somewhere around 5 million or above, because anything over 5 million seems to have a much higher audit risk than if it’s under 5 million. Most transactions are under 5 million, so.
Joey Romero Now, so that’s the audit side of that. But how often do they get disqualified? And what do you see the most? I guess, what triggers those disqualifications more than anything?
Bill Exeter I’m just kind of noodling here. Most of the ones I’ve been involved with in terms of audit, they’re not disallowed. They’ll find things like, well, I guess perfect example would be on your closing statement. There’s really three buckets. There’s your routine selling expenses, which we talked about before your brokers, commission, title, escrow, documentary, transfer tax, those are permissible. There’s two other buckets. One is any lender related items. So interest expense, demand, statement fees, things like that. And your third bucket would be operating expenses. So proratedrents, prorated HOA fees, prorated property taxes, the second and third bucket are not permissible. Most people pay those through closing anyways, and it doesn’t hurt the 1031, but it does mean those items that are paid are, you’re using exchange proceeds to pay for operating expenses instead of buying replacement property. So that triggers a tax consequence, not a huge one, but it triggers a tax consequence. Most people don’t know that, and a lot of tax advisors don’t know that, so they report it as 100% tax deferred, they get audited, and all those little things get added back and triggers an issue. But then you get some people who don’t identify, or if they do identify, it’s after the 45 day deadline. Occasionally you’ll get somebody who closes on the purchase on the 100 knee first day. So those are certainly disallowed. They’ll find something like that qualified use as an issue. Maybe they moved into the property day one. You can’t do it. That’s personal use. It doesn’t happen very often, but, you know, some people try to play the game and doesn’t work. So usually, those are types of things we see.
Joey Romero Let’s say, if I hold properties in my self directed IRA. Can I exchange those?
Bill Exeter Great question, you know, the self directed IRA, it’s either a traditional IRA or Roth IRA, in most cases, they’re either tax deferred or tax free already. So if you own real estate in that, you could certainly do that. We’re an IRA custodian as well. So you can certainly do that, that’s our sweet spot. So if you’re selling real estate, it typically is not going to need a 1031 exchange. But in some cases, if you are considered to be a non passive investor, because investments in the IRA are supposed to be passive. If you’ve invested in something that’s an operating business, it might trigger unrelated business, taxable income or UBTI, or if you’ve leveraged the real estate, it could be unrelated debt, finance income or UDFI. Nope. So that means when you sell the real estate, you trigger a taxable event. And the IRA actually may have to file a tax return at 990-T, but if you do a 1031 exchange at that point inside the IRA, then you don’t recognize any gain, and therefore you don’t have to worry about UBTI or UDFI. You don’t have to file a 990-T so if you’re going to, you know when, anytime you invest in real estate or any kind of an operating business, talk to your tax advisor, find out whether it’s going to trigger unrelated business taxable income or UDFI, and if it is, then talk to them about doing a 1031 before you actually sell.
Joey Romero And if they don’t know, get another CPA.
Bill Exeter Exactly. Yeah. And what I said, they’d probably just glazed over, because that’s complicated stuff.
Joey Romero Yeah. Now, what does it mean when it’s a step up in cost basis?
Bill Exeter Good question. So kind of a simple answer would be, let’s say you bought real estate years ago for 100,000. Today, it’s worth a million and you pass on. You’re going to leave that property to, you know, kids or grandkids or friends or, you know, whatever it might be. The fact that the value of that $1 million property is included in your estate for estate tax computation means that they can’t double tax you, so it cannot be counted as part of your capital gain computation. So when you pass the values included in your estate, whoever inherits the property gets a step up, which means the cost basis in the property is increased from that $100,000 that you bought it for up to the fair market value at the date of death. So your kids or grandkids, or whomever, their cost basis gets stepped up to 1 million they could sell it the next day, literally, for $1 million and pay zero taxes.
Joey Romero Wow, that’s a… Wow, that’s interesting. What’s the biggest mistake you’ve seen in the in your 40 years of doing 1031, exchanges? What’s the biggest mistake you’ve seen?
Bill Exeter Biggest mistake number one, not paying attention to the requirements. And I know it’s tough, because you get all sorts of documents, reams and reams of paper when you’re doing real estate, and nobody reads it, and that’s part of the problem. So we’ve talked about trading down in value, not reinvesting things, identification and all of those things. And it’s amazing how many times people either don’t identify or they think they can identify anything, and then acquire something else, all sorts of just kind of crazy ideas, and then they’re really upset when they find out their exchange is disallowed because it they didn’t follow the rules. The rules are documented everywhere. I mean, they’re on marketing brochures, they’re on websites or all the legal documents. So read what’s out there, read what’s provided to you, so you know what you’re expected to do. And then it’s a piece of cake, really, but it’s just, you know, people are busy. They just don’t read anything. They sign it, and that’s it. And then all of a sudden they get surprised. The biggest mistake is not paying attention to the details, not reading, not doing your homework.
Joey Romero We had an investor that, you know, we, we do it at the boot camp, and then it’s available on video so they can go back to it. And we always tell them, if you’re going to do a 1031 we’re going to need some time to set some things up. You know, give us at least two weeks prior to your closing date. We explain that. And I, you know, inevitably, I got one of our investors. Now we’ve taken 175 investors to Florida. And ‘Joey, Hey, I just sold my property. We closed yesterday. Man, I’m ready to exchange.’ And I was like, ‘man,’ I was like, ‘we’ve been talking about this for the last six months leading up to it that I said, Hey, before you sell, make sure we set everything else up’. And he’s like, that’s why he just, he just had to pay taxes on it. So that was a…
Bill Exeter Yeah. And unfortunately, there’s no way to go back and unring the battle, so.
Joey Romero That was hurt. Now I asked you, what’s the biggest mistake, but what’s the most interesting exchange you’ve ever been a part of?
Bill Exeter Oh, this goes back, well, a couple of them that come to mind. This goes back before they change the rules to where it only applies to real estate. So probably the most interesting was an exchange of a 747, and the attorneys said, We don’t want to deal with sales and use tax issues, so we want to do it at international airspace. So we all got on the plane, and it hadn’t been, it hasn’t gone green yet, so it’s still built it hasn’t been built out. None of the seats are in there, except they put in just enough seats for the closing gene. And we flew out in international airspace, did the deal, did the wire transfer and everything, and then flew back and and then, and they wouldn’t let me fly the plane.
Joey Romero Oh, man, you should’ve held him hostage.
Bill Exeter Yeah, the oddest exchange we ever done was an exchange of meteorite. And we got the phone call. We thought the guy that got the phone call said, I think this is a crank phone call, but, you know, he’s asking really good questions. So I took the questions, we took the call, and sure enough, he had this meteorite that he’d owned for like, 10 years. He basically found it years ago and put it in the museum and reported it on his tax return as an asset held for investment, which is shocking and out of the blue he got an offer to buy it for a million dollars. So he sold it and said, what can I exchange it for? And it’s like, well, that’s a good question
Joey Romero …that sets a precedent right here.
Bill Exeter Yeah. And I said, well, first of all, I could tell you that the IRS has never ruled on an exchange of meteorites, but the question is, what’s like, kind is obviously another meteorite, and so I don’t know who would do that. And he goes, why?
Joey Romero Some other, some other nerds about it. But I said, you know, do do minerals qualify, or, or certain kinds of gems, or, you know, I don’t know. It’s just hard to say. In his case, he ended up exchanging for a, I guess you caught a portfolio of other meteorite. So it was interesting. I learned a lot on that one. Well, Bill, were wrapping it up here. Can you just tell folks how they can get a hold of you if they’re interested in other than calling us, how can they reach out directly to you?
Bill Exeter Sure, certainly, call-in you guys. We can chat, do a conference call together if they want to reach out, direct website is a good way. We got a lot of the technical information on the website. So that’s Exeterco.com. So that’s E-X,-E-T,-E-R-C-O.com, and then, or if you want to call direct, I’m out of the San Diego headquarters office. So our number there is 619-239-3091, so 619-239-3091.
Joey Romero Well, Bill, I really appreciate you jumping on pretty short notice. I know we were, we’ve been meeting ever since we’ve we started the boot camp. You know when it’s relevant. You know, we don’t always have an exchange going, but I appreciate your time. And you actually doing a refresh for our audience, because we know we get brand new investors you know coming along all the time. So thank you.
Bill Exeter Most welcome. My pleasure. Anytime.
Narrator For more information on hard money loans, trust deed investing, and upcoming events with The Norris group. Check out thenorrisgroup.com. For more information on passive investing through the DBL Capital Real Estate Investment Fund, please visit dblapital.com.
Joey Romero The Norris group originates and services loans in California and Florida under California DRE license 01219911. Florida mortgage lender license 1577 and NMLS license 1623669. For more information on hard money lending go to thenorrisgroup.com and click the hard money tab.