This is the story about a family who had been investing in Real Estate for years who found themselves vulnerable due to the onset of the COVID 19 Pandemic.
Mr. and Mrs. Mendoza had long believed in Real Estate as a means to grow family wealth and teach their children about finances and building and maintaining assets that could help provide for their immediate family as well as serve as their legacy. To hear it told, the whole family had been involved over the years cleaning up properties, landscaping, doing repairs to their investment properties as needed.
As time went on they found themselves doing a series of 1031 exchanges. They had decided again to sell the apartment building they owned and hoped to pursue an exchange into commercial property. They sold their property and got a good price for it.
As they entered their 1031 exchange and their 45 day period to identify replacement property, their broker found 3 attractive opportunities for them, one of which they hoped they could close on. One was a triple net leased gas station and convenience store, another was an office building and the 3rd was a movie theatre complex occupied by a major theatre operator.
They put offers in on all three as their initial 45 day identification widow was passing. The sellers of the gas station/convenience store as well as the owners of the office building accepted other offers but the theatre complex owner negotiated with them until they had an accepted offer. As each side started working through their respective contingencies, the COVID 19 Pandemic hit the country hard and State and Local governments imposed quarantines, and forced temporary closures of many businesses, movie theatres being one of them.
At about this time, the Mendoza’s became aware of the Deferred Sales Trust primarily through searching on the internet. They wanted to know if the DST Strategy could be used to rescue them in the event they chose not to pursue this purchase or if the exchange might possibly fail. After due research and review, they requested to retain our law firm to create a DST Structure for them as their “back-up” strategy, to which we agreed. What helped somewhat in their decision was the conditional nature of all of our agreements: To which, you will receive legal advice and creation of the DST Trust Structure as well as integration with 3rd parties related to the sale transaction, but no fees would be due unless you actually sell your asset using the DST and the proceeds of sale are placed into your Trust.
As the escrow period went on, the previously announced “temporary” quarantine measures and business closures were being extended on an indeterminate basis. Further, under these conditions, the Theatre operator, who was supposed to sign a 10 year lease extension as a condition of escrow announced that while they ‘wanted’ to continue to operate in this location, they were not prepared to sign a lease extension under the current uncertain climate.
The Mendoza’s felt like they were doomed. Most of their family wealth was tied up in the real estate they sold and if this exchange failed, as it seemed poised to do, they would be hit with more than $1 million in taxes. They felt they were about to take a giant step backwards. It wasn’t until near the end of the exchange that Congress granted a temporary short term extension on 1031 exchanges in progress, but that was seen as too little and too late. Instead they chose to close their exchange at the end of the period and move their money into the Deferred Sales Trust. Their plan, then and now is to use the majority of their proceeds to purchase additional investment real estate. Only now they have the luxury of finding the “right opportunity” at the right time, instead of again going through the agony of meeting rigid 1031 rules and restrictions. This ordeal also made them realize that they were extremely over-weighted in real estate and are using this outcome as a way to buy back into an asset class they know and still believe in, but also to be able to diversify their investments into other asset classes as well.
It doesn’t take a sudden pandemic to throw your plans overboard. Many investors seeking to enter into a like kind exchange also may find difficulties identifying suitable upside property or face the risk that a property they hope to purchase has serious defects or cannot close within the scheduled timeline. I hope that this story can help educate investors that there is a way out, and that the way out may just be better for you than the strategy you once sought.