What are some of the key similarities and differences between a 1031 exchange and an Opportunity Zones investment? And how do the investor profiles of the two programs differ?

Real estate broker, developer, investor, and 1031 expert Thomas Morgan joins me today to discuss these topics and more.

Note: this is Part 1 of my conversation with Thomas. Click here for Part 2, where we discuss impact investing in opportunity zones.

Click the play button below to listen to Part 1 now.

Episode Highlights

• What a Section 1031 exchange is, and why it’s one of the greatest wealth building tools of all time
• Why Thomas refers to triple-net leasing as mailbox money.
• Some of the most common questions about 1031 exchanges.
• Key similarities and differences between Section 1031 and the Opportunity Zones program.
• How the investor profiles of 1031 exchanges and Opportunity Zones differ.

Featured on This Episode

• Thomas Morgan on LinkedIn
• COMPOUND Global
• Andrus & Morgan
• 1031 Navigator
• 1031 Exchange Passive Income and Investment Series Podcast
• Triple-Net Lease (NNN) on Investopedia

Industry Spotlight: COMPOUND Opportunity Fund

Founded by Thomas Morgan in Aspen, Colorado, COMPOUND is an impact investment studio that creates, sources, and manages global impact investments in real estate. The COMPOUND Opportunity Fund focuses on double and triple bottom line projects in opportunity zones throughout the United States.

Learn More About COMPOUND

• Visit COMPOUND.global
• Call COMPOUND Global: (970) 618-4086

About the Opportunity Zones Podcast

Hosted by OpportunityDb.com founder Jimmy Atkinson, the Opportunity Zones Podcast features guest interviews from fund managers, advisors, policymakers, tax professionals, and other foremost experts in opportunity zones.

• Subscribe on iTunes
• Subscribe on Spotify
• Subscribe on Google Play
• Subscribe on Stitcher
• Subscribe on TuneIn

Show Transcript

Jimmy: Welcome to the Opportunity Zones Podcast. I’m your host, Jimmy Atkinson. My guest today is national commercial real estate broker, developer, and investor, Thomas Morgan. He’s also a fellow podcaster, host of the “1031 Exchange and Passive Income Series” podcast and “COMPOUND,” a new show focused on impact investing.

Over the course of his career, Thomas has been involved in over $1 billion of real estate deals in over 35 states. His primary firm specializes in triple net 1031 exchanges. He also has a passion for adaptive reuse, impact investments, conservation, and public street art.

And to that end, he is currently creating projects and raising funds for his COMPOUND Opportunity Fund, which invests in opportunity zone real estate nationwide with a focus on social impact and environmental progress. He joins us today from his office in Aspen, Colorado. Thomas, welcome to the show.

Thomas: Hey, Jimmy, how are you doing?

Jimmy: Good, man. I’m glad we finally connected on the podcast here. We’ve been in touch for a few weeks now. I know we’ve been talking about getting you on. And I’m excited to have you here today.

Thomas: Yeah, super psyched to be here. And I wanna just acknowledge you and thank you for your shows you’ve done over the last few weeks. I think you’re fulfilling a unique niche. And your guests have actually been super helpful contacts. I’ve been reaching out to a lot of them, they’ve been really receptive. And I have a lot of new friends and business acquaintances because of it. So thank you.

Thomas: I’m glad to hear that. That’s awesome.

Jimmy: So let’s start us off. Some of my listeners are just hearing about opportunity zones for the first time. And maybe they’re not that familiar with real estate investing in 1031 exchanges. So I was hoping we could start at square one. Can you tell us what is the 1031 exchange?

Thomas: Yeah. So what I like to describe 1031 exchanges as is one of the greatest wealth-building tools known to mankind. You know, it’s not really a secret, but it’s a tool that the wealthy use to continually defer taxes from real estate sales over the years. And 1031 exchange refers to section 1031 of the Internal Revenue Code. And a lot of people think that you have to exchange the property, you have to find another property and have a seller agree to exchange it.

But basically, you just sell a property that you have a gain in and you’re looking to defer the capital gains. And then you have to find another suitable property that you wanna invest in to essentially buy and that completes the exchange. And then there’s some guidelines you have to follow under the Internal Revenue Code with some time frames and procedures, which we can get into if you want.

But going back to the first point about the greatest wealth-building tool, essentially if you…the example I like to use, let’s say, a $3 million sale, let’s say your family has owned it for 50 years, 20 years, whatever, you have a $3 million property you’re selling somewhere, what most people don’t realize is, it’s not just capital gains tax you’re gonna be liable for. if you’re in a higher income tax bracket, you’re gonna be subject to the healthcare or Obamacare tax.

And then you’re also gonna have what’s called depreciation recapture. And a lot of people don’t know that. But all the depreciation you’ve taken over the 50 years of owning that asset, the government’s gonna try and tax you or they’re gonna tax you on that income you’ve sheltered. And so by the time you put all those three things in there, it’s not uncommon for someone with a $3 million sale to have $1 million tax liability.

And so today, there’s kinda two ways to look at it. You can sell it and write the check for $1 million for your tax to the government and say goodbye to that money, or you can arrange to do a 1031 exchange and buy another piece of property and use that million dollars that would, otherwise, go to tax, and keep it in your investment pool indefinitely. And you can keep 1031ing, essentially, until you die, as long as you follow the code.

Jimmy: Yeah, that’s great. That’s a good primer. And I do wanna ask you more about 1031s. And we’ll tie into how they compare with opportunity zones in a few minutes here. But I wanted to talk with you more about triple net properties. Now, your firm, Andrus & Morgan, specializes in triple net 1031 properties. And again, for my listeners who may be new to real estate investing, could you just explain what triple net means, what triple net properties are, and provide some examples.

Thomas: Yeah. So Andrus & Morgan Company is my real estate brokerage. And we also do some of our development and investment through that company. And then we run a service or a website called 1031navigator.com. And essentially, we’re investment real estate brokers. We work all over the country and we specialize in 1031 exchanges into passive income properties or other types of income properties.

Most of the people I find doing 1031 exchanges who come to me, they tend to have owned a property really long time. They were hands on owners, I call them kinda legacy owners, where they might have, family own property, industrial office multifamily where they have to roll up their sleeves. They’ve been managing property or their family has been managing property for 10, 15, 20 years. And they’re sick of the management, and so they’re looking to defer those taxes that we talked about earlier and roll those into a passive investment where they don’t have to do anything.

And so at triple net property, if you’ve heard the term triple net, it comes from triple net lease, which triple net’s typically the three N’s are taxes, insurance, and maintenance. And the leases are structured that the tenant typically pays those expenses and/or manages all the operations of the property. So most of my clients are actually buying what are called single tenant triple net properties.

And we do a lot of Walgreens, CVS, Dollar General, fast food-type stores, Arby’s, Pizza Hut, things like that. And the leases are very, very long term. Usually minimum of 15 years, maybe 20, or even 25 years, depending on the tenant. And the landlord does not have to do anything. They just collect the rent every month. And, in the business, we kinda jokingly refer to it as mailbox money or an armchair investment. So people can go from tenants, termites, and toilets, and their multi-family or their office building, or whatever they’ve been doing to mailbox money, and just receive the net rent. And the tenant takes care of everything depending on the lease.

Jimmy: Yeah. That’s great. Yeah, with the triple net lease, in particular, it is purely passive. There’s no taxes, no insurance, no maintenance for the owner to pay, they all goes to the tenant.

Thomas: Jimmy, those things are there. You know, there’s definitely taxes, insurance, and maintenance. But under the lease, the tenant is supposed to take care of them. So, you have to watch your tenant to make sure they’re doing it, but for all practical purposes, if the tenants doing their job, the owner doesn’t have to do anything.

Jimmy: Right. And I guess that’s the big if. As long as the tenant does his job, it’s purely passive.

Thomas: Correct.

Jimmy: Now, let me back up here for a minute. Thomas, if you could tell me a little bit more about yourself, tell me your story. How did you get started with this? And what was your journey, like, to get to where you are today?

Thomas: Well, I hail from just outside of Flint, Michigan. Everyone’s heard of the Flint and the water crisis. And here I am today, just outside the Aspen, Colorado. So I’m kind of a person full of dichotomies, let’s say. And I can tell you more about that when we talk about compound. But I originated from Flint. My dad was in the hardware business, own hardware stores, owned a few strip centers, and I saw him go to work every day, and essentially have to open up the stores.

And then I met a friend’s dad who was a big real estate developer out of Chicago when I was in college. And I had lunch with him. And he said, “The biggest difference between me and your dad is I don’t have to go to work every day and open up the doors. You know, someone else, essentially, the tenants open up the doors for me, and I make my money by them paying me rent and/or by buying or selling the property.” And he said something, two things that stuck with me, and I was probably 19 years old. He told me about cap rates. And he explained it very simply. And he used an eight cap as an example. And so that stuck with me. We use that every single day in our business and of commercial investment real estate.

And then he also said that good deals find good money. And so that stuck with me both in what I do today with the triple net investments, that are long-term passive, safe investments that people wanna pass on to their kids. And I want my clients to come back and be able to be proud of what they bought and send their friends to me. But it also goes to what we’re doing with compound in the impact investment space, so good deals find good money. Meaning that the the right kind of projects will attract the right capital aligned capital, and move things forward.

So basically, that got me kind of interested in commercial real estate. And I ended up getting a business degree from Michigan State. Came out to Colorado for a summer job. And that was I guess over 20 years ago now, and never really been back and got to work with a lot of interesting people. Throughout the years, clients are all over the place, properties are all over the place. And I work on every single type of property, mobile home parks, apartment buildings. I’ve done bed and breakfasts, I’ve done conservation easement-type deals, gas stations office you name it. I’ve work either as a broker, appraiser, developer, or owner of almost any kind of property type.

And some point, I stumbled upon the CCIM Institute and got my CCIM designation in 2007. And they teach you all about time value of money, internal rate of return. And then the networking opportunities provided by CCIM have just been tremendous. And I realized that commercial real estate is a national business living here in the mountains. It doesn’t have to be just limited to where you are. And the internet over the last 10 years has really progressed things even more. So we can work from wherever, the clients or wherever, properties are wherever, it’s a national business. So that’s a little background to where I am today.

Jimmy: That’s great. You know, what a unique perspective change that must have been to see your dad open up that store every day for 18, 19 years, and suddenly you have a big perspective shift. And you’re right, commercial real estate is a national business. It’s also a people business. And I’m sure the CCIM helps you network and meet new people all over the country.

Thomas: Yeah. No, it’s a fun business. You know, it’s a challenging business but there’s a lot of savvy, smart people. And there’s a lot of creative people in it. The depth of it is immense. You know, if you to just say commercial real estate and then you have investment real estate, then you have all the sub-property types, and then you have all the different people doing stuff with debt and/or equity on the financing side, then you have the tax people, and you have the law, it’s a really dynamic business. And you get to interact with a lot of different professions different characters and different personalities who all do business different ways. So it’s always kind of fun to… when you actually close a deal or achieve the objectives, you can celebrate, and that’s a fun thing to do.

Jimmy: Yeah. The people behind that deal sometimes can read like end-credits of a movie. There’s a lot of names that scroll up that screen kind of just like a movie.

Thomas: Oh, yeah, sure.

Jimmy: Now, I want to ask you about compound. But before I do that, I wanna go back for a minute and talk to you more about Andrus & Morgan and what you’re doing there. What are some of the most common questions that you get about 1031 exchanges and the work that you’re doing at your primary firm there?

Thomas: So we get a lot of the same questions over and over. So what I realized is, if I could stop answering those individually one-off I put them on the podcast started blogging a long time ago and I’ve answered a lot on YouTube. But a lot of them relate to the actual 1031 exchange process, which, believe it or not, a lot of accountants really don’t know much about.

So the sellers of property have heard it, heard about it, or their friends know about it, and so they go out searching, looking for answers. But one of the biggest fallacies is that exchange people think they have to actually trade from property A to property B to make it… you have to have a seller aligned with actually taking your property and it’s an even trade, but it’s not. It’s called an exchange, but essentially, you sell and then you buy something new to complete the exchange. And you have to do it right for the code. You have to get what’s called a qualified intermediary to hold the funds and do some paperwork, or that can disqualify the 1031 from the IRS.

But basically, right before you get ready to close the property you’re selling, you winded up with the qualified intermediary, the QI, and they essentially take the funds when you sell. They take the funds and they hold them for you while you’re finding another property. And you have up to 45 days from when you close to identify up to 3 properties, or there’s another rule called the 200% rule, which you can do.

And then you have 180 days total to close on 1 or all those 3 properties. And then that successfully completes the 1031. So those points, we’re talking about 45 days, 180 days, QI, 3-property rule, 200% rule, those are some of the main questions about how to actually do a 1031. And I’m not a legal person or a tax person, so I always defer to those professionals. But those are the basic questions I answer.

And then the next part of the business is actually the real estate investment advisory and understanding what people’s goals are, what they’re trying to achieve with their money. They’re just looking to defer tax, if that’s the main reason, or if they’re looking for a certain cap rate, or a certain internal rate of return. Do they want to invest close to home? You know, do they want 12% return? Are they okay with a 5% return? You know, a lot of the people I work with their families, so understanding their goals, what their family objectives are, and then matching a property to those goals, and then sorting through the hundreds or thousands of properties to complete that exchange in a suitable investment.

You know, anybody can 1031 exchange into a crappy property, the key is being able to defer those taxes and increase your wealth. I call it create, build, and protect wealth is what we’re trying to do with commercial investment real estate. So those are the three things that we’re trying to do, and making sure it’s a suitable property that achieves those goals.

And that goes into the triple net investments of why a tenant is located where they are how many cars are at the corner, what the demographics are like is the area growing or declining all the different factors. And the internet’s helped us with that because we can analyze any property in about a minute get all that data, and then make a decision on a property pretty quick.

Jimmy: Good. So let’s shift gears and talk about opportunity zones now for a minute. I want you to relate opportunity zones to 1031 exchanges, since you’re my 1031 exchange expert. There are some similarities between the two programs, but there are a lot of differences as well. Can you talk about the differences and similarities between the two programs?

Thomas: Yeah. I think the main thing is they’re meant to help people defer taxes, and then therefore, spur investment in the economy and in specific areas. The main thing with 1031s is you can invest anywhere, and you can keep deferring the taxes indefinitely, you can keep doing 1031 exchanges into other properties, and keep reusing that money that you would otherwise pay tax, and keep growing that money until essentially you die, or until you do some estate planning.

And that’s when your basis steps up. Whereas with the opportunity zone program, you’re obviously gonna be limited by investing in qualified opportunity zones, so specific areas. And then you’re gonna have to pay some tax in 2026. And if you do it right you’ve covered this on the show extensively so I don’t think we need to rehash it, but essentially, you can reduce your tax by 15%. But then in 2026, you’re gonna have to pay the tax, where the 1031, you can keep deferring.

But then I think the biggest thing is on the backend where if you’ve held up the property for over 10 years, your basis get stepped up while you’re alive or whatever your estate planning is doing, your basis you don’t have to pay any more gain. So you’re essentially out of the investment, you’ve paid a reduced tax, and you can get exponential gains on that property, hopefully if you’ve made the right investment. I think the two biggest differences, Jimmy, are the 1031, you can invest anywhere, and you can defer the taxes definitely. Opportunity zone program, you have to invest in the opportunity zones, you’re gonna have to pay some tax, but then you’re gonna get some benefit on the backend.

Jimmy: Yeah, I agree. I think in some ways, the 1031 exchange is more flexible than opportunity zone, because you’re not limited to certain geographies. But in other ways, the opportunity zone program is much more flexible because, first of all, it doesn’t have to be a like kind exchange. Your capital gain that you’re deferring can come from anywhere. It doesn’t have to be real estate. It can come from the sale of art, or stock, or any capital gain.

Thomas: Yeah. Yeah, you’re totally right. The 1031 exchanges like kind, so you have to go real estate to real estate, and then the OZ program, you can go from sell stock, or art, or jewelry and go to real estate, or vice versa, which provides a lot of flexibility for people.

Jimmy: Yes. Yeah. But it isn’t flexible in that it’s limited to certain geographies. And those being by, for the most part, low-income geographies as well. So that’s a challenge at the OZ program. So who are the different types of investors who may prefer a 1031 exchange to an opportunity zone program or vice versa?

Thomas: Yeah. No, that’s a great question. And an example I have is I’m kinda wearing two hats with my 1031 business and the new impact investing business. I’m talking to my existing clients about doing it, and I’m talking to them about opportunity zones, and talked to one long-time client done three exchanges with over the years. He splits his time between New York City, the Hamptons, and Palm Beach.

And he said, “Thomas opportunities don’t sound great. But I’ve always been a location, location, location investor. And that’s the way I’ve made my money. And that’s what I know. I’m not gonna go into a low-income area or poverty-stricken area just for some tax benefits. You know, I can do a 1031, not have to pay any tax keep deferring my tax, and I can buy grade-A real estate.”

However when I talk to people who are a little more, let’s say less financially-driven, and more socially conscious the point of the OZ program was revitalization. And people wanna feel good about where they’re investing their money and what they’re doing with their money. And the opportunity zone program provides that extra juice for someone to invest in an area they otherwise wouldn’t invest in. So I think those are the two biggest differences is investor profile of, one, maybe more money-driven, and two, the other one more impact or socially conscious-driven.

Jimmy: That makes sense. Do you have anybody who’s doing both, who’s kinda hedging a little bit, who’s interested in 1031 exchanges and doing some 1031 exchanges, but also wants to have that social impact and do some opportunities and investing as well? Do you think those investors are out there who will do both?

Thomas: Yeah. So you touched on this in one of our conversations the other day about can you do at 1031 into an opportunity zone? And you can so people can invest in opportunity zones whether or not they’re taking advantage of the OZ program or not. But a lot of 1031 capital if they can invest anywhere, they’re probably gonna choose other areas.

So I think it goes back to the mindset of the investor and what their goals are. But for example this is kind of where the compound thing came from, is I’ve had 1031 clients. I’ve done a little blogging about essentially a sustainable 1031s or LEED-certified buildings, green buildings for 1031 some people are structuring solar and alternative energy projects for 1031s. And so there’s people out there searching.

I had a woman, she’s from New York City, still owns some property there, but she lives in Italy enjoying the good life. She called me and said, “I’m selling an old industrial building in New York City. I have $2 million, I don’t wanna just put it into Dollar General or Walgreens. You know, I could, but I don’t need that extra income. I don’t really need that security. I’d rather just feel good about what I’m doing with the money. And so what can you put me in that would be you match that?”

So we’re looking at some essentially organic farm investments. In most of the things we work on, Jimmy, are income properties. So they have to generate some sort of annual income. So, like, organic farms would be one. We’re looking at some forestry properties or timber properties where she could actually buy it and manage the forest sustainably, but then have an income stream from selling off certain tracks or mature growth trees.

And then we’re also going back to just green LEED-certified buildings and/or tenants that she would feel good about owning. Natural grocers is a big tenant right now that kind of up there with Whole Foods that people like to see. You know, some people like Starbucks they like their social impact and what they’re doing. I mean, it’s not green by any means but there’s different opportunities out there for people who wanna do a 1031 outside of an opportunity zone. But that’s just an example we’ve been working on.