Author Topic: 1031 Exchange or just pay the tax and be done?  (Read 3070 times)

WanderLucky

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1031 Exchange or just pay the tax and be done?
« on: September 23, 2021, 09:01:38 PM »
Has anyone here recently done a 1031 exchange? How difficult was it to complete? Any tips?

My tenants are buying a house and planning to move out this winter, so I am considering finally selling this rental house in the spring. I no longer live in the same city as the rental, and it was never a great financial decision to hold on to it anyway - I thought I would one day move back in, but now I have no desire to live in that city again.

I would love to be able to 1031 exchange into a property closer to where I currently live, and hopefully find one that I might want to someday move into as my permanent residence (like in 5 years).

My rental property should sell for ~$1.2M+.
If I just pay the capital gains tax, I would clear ~ $530k after taxes and fees (assuming tax rates don't rise; my CPA figured this out for me so it should be fairly accurate).
If I do a 1031 exchange, I should have about $715k to roll into a new property, but I'd have to get financing of ~$500k.

1031 exchanges seem difficult and stressful, especially the part of about identifying 3 properties within 45 days of a sale - my new city just doesn't have much coming onto the market in the price range that I'd have to buy in (~$1.3M) so that part is going to be tough. Plus, I need to stay employed at my contract job in order to get financing for the new house, and I'm kind of over that too.

But it also seems silly to leave over $200k on the table just because 1031 exchanges seem hard. Although on the other hand, if I invest this money and got 7% growth I could get that $200k back in about 4 years (if I used the compounding interest calculator correctly). Then again, if I find my dream home, it may be a good opportunity to get it before prices go up even more as I don't think my area is going to cool down much in the coming years.

Any thoughts on any of this or maybe something I'm not thinking through?

jeromedawg

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Re: 1031 Exchange or just pay the tax and be done?
« Reply #1 on: September 23, 2021, 10:33:06 PM »
Has anyone here recently done a 1031 exchange? How difficult was it to complete? Any tips?

My tenants are buying a house and planning to move out this winter, so I am considering finally selling this rental house in the spring. I no longer live in the same city as the rental, and it was never a great financial decision to hold on to it anyway - I thought I would one day move back in, but now I have no desire to live in that city again.

I would love to be able to 1031 exchange into a property closer to where I currently live, and hopefully find one that I might want to someday move into as my permanent residence (like in 5 years).

My rental property should sell for ~$1.2M+.
If I just pay the capital gains tax, I would clear ~ $530k after taxes and fees (assuming tax rates don't rise; my CPA figured this out for me so it should be fairly accurate).
If I do a 1031 exchange, I should have about $715k to roll into a new property, but I'd have to get financing of ~$500k.

1031 exchanges seem difficult and stressful, especially the part of about identifying 3 properties within 45 days of a sale - my new city just doesn't have much coming onto the market in the price range that I'd have to buy in (~$1.3M) so that part is going to be tough. Plus, I need to stay employed at my contract job in order to get financing for the new house, and I'm kind of over that too.

But it also seems silly to leave over $200k on the table just because 1031 exchanges seem hard. Although on the other hand, if I invest this money and got 7% growth I could get that $200k back in about 4 years (if I used the compounding interest calculator correctly). Then again, if I find my dream home, it may be a good opportunity to get it before prices go up even more as I don't think my area is going to cool down much in the coming years.

Any thoughts on any of this or maybe something I'm not thinking through?



I'm assuming you have a loan on the rental property currently?

Besides making sure you can actually cashflow in the area you're considering buying into... I think it depends on if you like being a landlord or not. Or potentially if you'd be open to getting into VRBO/vacation rentals. When you say you want to 1031 into a property closer to where you live, how close? Is there a minimum and max mileage/range as far as how close/far you'd want to be? There's also an option on doing exchanges into multiple properties, but that could get convoluted with the loan and all that.

This is a tough one but I think it could be hard finding a single property that's $1.2mm that's going to cashflow really well for you and get you a good ROI. Unless you can look into breaking that up into multiple properties that can cashflow well, maybe it is better just to cash out on the place.

Dicey

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Re: 1031 Exchange or just pay the tax and be done?
« Reply #2 on: September 23, 2021, 10:36:52 PM »
There are people who specialize in 1031s. For them, it's not hard at all. But the market is crazy now and there is little time to make a well thought out decision.

If you invest in the wrong property, it could cost you a lot more than the taxes you would owe. Paying a slug of your taxes isn't the worst thing that could happen in your life.

DH and I did an extensive rehab/flip project and elected to just pay the taxes on the sale. Then the pandemic happened and we are positive it was worth every penny. Your mileage may vary, and others will have different opinions, but at least I'm someone who has actually been through the same decision making process IRL.

If you sell and get out, you will still have a shitload more money than you started with.

LightStache

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Re: 1031 Exchange or just pay the tax and be done?
« Reply #3 on: September 24, 2021, 07:32:17 AM »
I sold my last rental in May without doing a 1031 and I regret it even though my tax bill was a lot lower than OP. My thinking at the time was that the real estate markets were bonkers so it was a great time to sell and there would be no good opportunities for a replacement property. As an soloprenuer with less than two years of income history, I also would have had trouble financing a replacement property.

But the $60K tax hit, mostly depreciation recapture, materially affected my FIRE timeline because that's basically the amount of spending money I need for a year while I'm starting up my Roth ladder.

In retrospect I wish I had held on to it until Spring of 2022 and then 1031'd into a DST. Even if that DST were to underperform compared to equities, carrying over the $60K in deferred taxes would still be better.

jeromedawg

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Re: 1031 Exchange or just pay the tax and be done?
« Reply #4 on: September 24, 2021, 08:38:30 AM »
I sold my last rental in May without doing a 1031 and I regret it even though my tax bill was a lot lower than OP. My thinking at the time was that the real estate markets were bonkers so it was a great time to sell and there would be no good opportunities for a replacement property. As an soloprenuer with less than two years of income history, I also would have had trouble financing a replacement property.

But the $60K tax hit, mostly depreciation recapture, materially affected my FIRE timeline because that's basically the amount of spending money I need for a year while I'm starting up my Roth ladder.

In retrospect I wish I had held on to it until Spring of 2022 and then 1031'd into a DST. Even if that DST were to underperform compared to equities, carrying over the $60K in deferred taxes would still be better.

DSTs are an interesting concept. My dad was considering doing this before his depression and anxiety struck and then it was thrown out the window. I researched it for the sake of due diligence but my mom didn't want to have anything to do with it (she is extremely risk averse, especially when it comes to making decisions on real estate - my dad basically used to handle all that stuff). Anyway, it sounds like a good means to "hold" property but maybe isn't the most efficient thing as far as cashflow is concerned. But sometimes (I think in cases like how the market is today) it's better to park your funds *somewhere* that hopefully isn't depreciating as fast as if you were to hold all or mostly cash.

WanderLucky

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Re: 1031 Exchange or just pay the tax and be done?
« Reply #5 on: September 24, 2021, 09:12:43 AM »

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I'm assuming you have a loan on the rental property currently?
Yes I have about $380k between the mortgage and a HELOC - payoff of these are included in the amounts I mentioned.

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Besides making sure you can actually cashflow in the area you're considering buying into... I think it depends on if you like being a landlord or not. Or potentially if you'd be open to getting into VRBO/vacation rentals. When you say you want to 1031 into a property closer to where you live, how close? Is there a minimum and max mileage/range as far as how close/far you'd want to be? There's also an option on doing exchanges into multiple properties, but that could get convoluted with the loan and all that.

This is a tough one but I think it could be hard finding a single property that's $1.2mm that's going to cashflow really well for you and get you a good ROI. Unless you can look into breaking that up into multiple properties that can cashflow well, maybe it is better just to cash out on the place.

I do like being a landlord. I've been one for over 10 years and have done both long-term and short-term rentals(Airbnb) and like both. I do not like worrying about my old house that will need constant upgrades, so would like a replacement property that needs a little less work.
As for location, I would like a replacement property in my current town. This is where I want to be long term, and I'd like a place that I would want to use as a permanent residence someday.

And you're absolutely right that it is difficult to cashflow at $1.2M with a mortgage. My area is extremely low on rentals, especially high end ones, but there is very high demand. I would have positive cashflow, but this is certainly not a 1% rule situation. The reason it could make sense is to secure a property that would eventually become my primary residence for retirement, and "save" $200k in the process.

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If you sell and get out, you will still have a shitload more money than you started with.
So true! I never imagined in my wildest dreams that my house would appreciate the way it did.

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In retrospect I wish I had held on to it until Spring of 2022 and then 1031'd into a DST. Even if that DST were to underperform compared to equities, carrying over the $60K in deferred taxes would still be better.
Sounds like I need to look into DSTs at least to understand more options. Why would you have waited until Spring 2022?

WanderLucky

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Re: 1031 Exchange or just pay the tax and be done?
« Reply #6 on: September 24, 2021, 10:28:40 AM »
A few more questions: Does anyone know what the price range is for a Qualified Intermediary (QI)? Does it matter where they're located? For example, would it be better to find someone where I'm selling or where I'm buying (same state, different city/county about 100 miles away)?

I still need to look into DSTs but outside of that option, I'm considering going through the 1031 exchange motions with a QI as if I'll do the exchange, but then if I don't find a great home within the 45-day period, that I just pay the tax. I just want to keep in mind the QI fees that I'd pay even if I don't go through with it. I had budgeted about $5k in the 1031 scenario (and not sure that is even enough) but nothing in the pay the tax scenario, although I imagine I'd still owe them money even if I don't successfully complete the 1031.

Geppetto

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Re: 1031 Exchange or just pay the tax and be done?
« Reply #7 on: September 24, 2021, 11:20:58 AM »
A few more questions: Does anyone know what the price range is for a Qualified Intermediary (QI)? Does it matter where they're located? For example, would it be better to find someone where I'm selling or where I'm buying (same state, different city/county about 100 miles away)?

I still need to look into DSTs but outside of that option, I'm considering going through the 1031 exchange motions with a QI as if I'll do the exchange, but then if I don't find a great home within the 45-day period, that I just pay the tax. I just want to keep in mind the QI fees that I'd pay even if I don't go through with it. I had budgeted about $5k in the 1031 scenario (and not sure that is even enough) but nothing in the pay the tax scenario, although I imagine I'd still owe them money even if I don't successfully complete the 1031.

A couple grand probably on each transaction (sale and purchase).

If you're buying back in to the same market, you can use an experienced local real estate attorney and have them intermediate all interactions with the QI.

You'll be about $190k-$195k richer in exchange for slight additional stress and complexity. Plus you'll have one under your belt and won't fear it the next time.

Good luck!

LightStache

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Re: 1031 Exchange or just pay the tax and be done?
« Reply #8 on: September 24, 2021, 01:05:34 PM »
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In retrospect I wish I had held on to it until Spring of 2022 and then 1031'd into a DST. Even if that DST were to underperform compared to equities, carrying over the $60K in deferred taxes would still be better.
Sounds like I need to look into DSTs at least to understand more options. Why would you have waited until Spring 2022?

One reason that's applicable to your situation -- I learned the hard way to always sell in peak season.

Two reasons that probably aren't applicable. One, I would have two years of business owner tax returns which would allow me to get financing if I ended up exchanging into another wholly-owned property. Two, if I were to go the DST route, I'd have to be an accredited investor and I won't meet the requirements until Jan 1, 2022.

cchrissyy

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Re: 1031 Exchange or just pay the tax and be done?
« Reply #9 on: September 24, 2021, 01:32:03 PM »
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But it also seems silly to leave over $200k on the table just because 1031 exchanges seem hard.

I would agree not to be scared off by it being "hard" but i think the concerns you outline are more than just "hard". specifically, the part about having to identify candidate properties and the deadlines for how both sales have to be time certainly scares me off. it's not a fear of paperwork or complexity. it's that i don't believe investment decisions should be rushed! especially not expensive, illiquid, longterm ones.  i suppose i'd feel different about the 1031 in a world with plentiful suitable properties available when you need them. but in my very limited experience as a homeowner and a landlord, good fits and good opportunities are hard to find!


all that said, I wanted to add you should look carefully into your core idea - is it even allowed to buy something with a 1031 to be your future primary residence? what happens to the taxes in that case?  I don't know. I'm just saying not to assume it's useful for your situation.

ontheheel

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Re: 1031 Exchange or just pay the tax and be done?
« Reply #10 on: September 24, 2021, 01:40:11 PM »
We did a 1031 in 2018 - rental property in North Texas had appreciated considerably, and we reinvested into two single family homes in Norman, OK. NTX real estate market has been on a tear the past 10 years or so, and we couldn't make anything cash flow based on rental rates, so we used geographic arbitrage and reinvested in another market where the numbers made sense. If we couldn't have done that, we would have just held on long term until the right investment appeared. As it stands, we doubled our cash flow, diversified our investments (two properties vs one), and are now riding a wave of appreciation (and rising rents) on the two new properties.

My recommendation is to see if you can locate a market where the numbers make sense (don't know if that exists right now, because I haven't been looking), and then make the decision. If the investment doesn't make sense, don't do it - whether that means cashing out and paying the tax bill or just waiting. Having the right team in place on the ground makes a HUGE difference - a realtor who you absolutely trust and who understands investing. Same goes for property management on absentee properties - we've had good and we've had bad - bad ones can cost you a ton of money and great ones you'll do just about anything to keep on your team.

soulpatchmike

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Re: 1031 Exchange or just pay the tax and be done?
« Reply #11 on: September 24, 2021, 01:54:23 PM »
I have done 2 conventional 1031 exchanges and was the real estate agent on a reverse exchange(they bought first with an intermediary title holder, then sold within the allowable timeline and title was transferred).
The 1031 exchange administrator is no different than an IRA administrator.  I would say it is about as complex as converting a traditional IRA to a Roth.  The challenge is in the timing.

You have timelines from when you close on the sale to when you have to use the funds for a purchase.  You have only 45 days to enter a contract and 180 days to close on it.  This might be the most complex part of it.  On a reverse exchange, you purchase first with an intermediary title holder until the exchange is completed.  You have 45 days to identify a buyer and close within 180 days.

Like I said the most complex part is the timing, but if you have a flexible buyer that can delay closing until you find a property to buy, it is very easy.

For me, I would never pay $100k+ tax bill if I had a reasonable way like 1031 exchange not to.  Keep in mind, you dont have to exchange a single-family for a single-family.  You can exchange an apartment for a warehouse or a warehouse for a single-family.  As long as sell price is the same or higher than buy price and both properties are used as income producing investments you can exchange as you like.
« Last Edit: September 24, 2021, 01:58:30 PM by soulpatchmike »

jeromedawg

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Re: 1031 Exchange or just pay the tax and be done?
« Reply #12 on: September 24, 2021, 02:05:06 PM »
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But it also seems silly to leave over $200k on the table just because 1031 exchanges seem hard.

I would agree not to be scared off by it being "hard" but i think the concerns you outline are more than just "hard". specifically, the part about having to identify candidate properties and the deadlines for how both sales have to be time certainly scares me off. it's not a fear of paperwork or complexity. it's that i don't believe investment decisions should be rushed! especially not expensive, illiquid, longterm ones.  i suppose i'd feel different about the 1031 in a world with plentiful suitable properties available when you need them. but in my very limited experience as a homeowner and a landlord, good fits and good opportunities are hard to find!


all that said, I wanted to add you should look carefully into your core idea - is it even allowed to buy something with a 1031 to be your future primary residence? what happens to the taxes in that case?  I don't know. I'm just saying not to assume it's useful for your situation.

You have to be careful with converting 1031s to primary residences.

https://www.1031exchange.com/converting-property/

You have to hold the property for 5 years before you live in it as primary according to the IRS

GuitarBrian

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Re: 1031 Exchange or just pay the tax and be done?
« Reply #13 on: October 06, 2021, 06:20:25 AM »
I did a 1031 exchange last year. I used First American Exchange. Which is part of First American Title. I figured if I was trusting them to do the title and escrow, then it made sense to do the exchange. I didn't have to identify either of my replacement properties, since I closed on both before the 45 days were up. $795 was the cost for the sale and first replacement property, with $250 more for the second one. Good luck!

Omy

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Re: 1031 Exchange or just pay the tax and be done?
« Reply #14 on: October 06, 2021, 07:09:28 AM »
I'm seriously considering a DST. No more tenants and toilets, and I can continue to defer capital gains and recapture taxes. Qualified Intermediaries in my HCOL area charge around $800.

WanderLucky

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Re: 1031 Exchange or just pay the tax and be done?
« Reply #15 on: October 06, 2021, 09:14:20 AM »
Thanks all for the excellent info and for sharing your experiences. I'm definitely going to at least try to make it work. I have friends trying to do a 1031exchange now and I am watching how it goes. They already missed out on buying a great house because their house hadn't sold yet, but that's to be expected in this market - Most sellers don't seem to be interested in a contingency to wait for your house to sell even if you offer way more than asking.

It sounds like the reverse 1031 exchange would solve my issue but I can't imagine the bank would be keen to do a bridge loan and Sellers likely won't want a contingent sale.

Anyone else have experience with DSTs they can share? At first glance of how it works, I'm not too interested because it sounds like you don't have control over what happens and you don't get your money back until the property sells. Since I want to use the proceeds of my sale to buy a long-term retirement home, I may be better off just paying the tax.

ca-rn

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Re: 1031 Exchange or just pay the tax and be done?
« Reply #16 on: November 14, 2021, 09:56:25 AM »
Posting to Follow.

Very curious about DST too.  Don't personally know anyone who has gone through this.

Live/landlord in multi unit building which has appreciated about 2.5x, nearly finished with depreciation(!!!).  Considered selling many times though getting paid on top of free housing is very nice.  But the depreciation recapture along with capital gains tax beyond 250K owner exemption will be scary.


Telecaster

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Re: 1031 Exchange or just pay the tax and be done?
« Reply #17 on: November 14, 2021, 10:16:22 AM »
I did one two years ago.  It did add one layer of complexity but it wasn't particularly hard.  Well worth the tax savings, IMO.

WanderLucky

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Re: 1031 Exchange or just pay the tax and be done?
« Reply #18 on: February 11, 2022, 08:07:36 PM »
I'm getting closer to making a decision on this, and have been digging into the DST option. The more I look at it, the more I like it as a backup plan.
From what I recently learned, when I identify the 3 replacement properties, I can also identify a DST as one of the 3. Then if  the other 2 properties don't work out, I can decide to exchange to the DST even at the last minute.

While I won't have control over the management decisions and the investment will be tied up for the length of the offer (3-10 years; I'll look for ones in the 3-4 year range), in the DST scenario I'd likely receive 4-6% annually (paid out monthly) + my share of the appreciation when the property sells at the end of the term.

One downside I've read is that the fees are high. I talked with a DST broker who said that the fees are 9% (can't remember if that was the average or a set %, probably an average), but I'm not clear if that comes off the top before the investment or if it's already included in the cashflow when they say you usually get 4-6% annually. Regardless, even if it comes off the top, at 9% it'll still be much cheaper than paying the capital gains tax (in my situation I figured those fees would be ~ 32% of what I would pay in capital gains).

I also like the idea of getting checks each month, that I will plan to invest in order to have money to put into another property to 1031 Exchange into once the DST property gets sold at the end of its term (or not; maybe by then I will have given up the idea of a "retirement property").

I also learned that another option to 1031 exchange into is a Tenancy in Common (TIC) - from my very limited research it sounds similar to DSTs except that you have more control. I'll research that one more next week.

Anyway, I'm posting all this to share what I learned about DSTs in addition to get any feedback on my plans and if I'm missing something or if any of that info sounds off (I could have misunderstood). Thanks!

maisymouser

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Re: 1031 Exchange or just pay the tax and be done?
« Reply #19 on: July 07, 2023, 01:55:02 PM »
Any updates on this one? We are in a similar situation and need to make some decisions within a couple months about whether we will pursue a 1031 or not.

eddy20

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Re: 1031 Exchange or just pay the tax and be done?
« Reply #20 on: July 08, 2023, 09:24:03 PM »
I have done seven 1031's exchanges over the years and they all worked out fine. Just know your market of the area you want to invest in and list the property you want to sell and buy into. I mostly had an up leg property found and already had listed the original property for sale. I understand it was not the strongest negotiation position to make a contingency offer; but if my property was already listed and at a marketable price the sellers were agreeable as they were investors themselves may also be looking for their up leg property. Of course much easier to deal with investors selling a property and not a individual selling their SFR, as investors understand the mechanics and advantages of a 1031 exchange.

WanderLucky

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Re: 1031 Exchange or just pay the tax and be done?
« Reply #21 on: August 15, 2023, 06:47:15 PM »
Any updates on this one? We are in a similar situation and need to make some decisions within a couple months about whether we will pursue a 1031 or not.
Just saw this. No updates from me because my tenants ended up not actually moving out until end of summer and by the time we could get in there and get it ready for sale, the market was quickly dropping and interest rates rising. So it's been a short-term & medium-term rental and we may try again in the spring.
Still thinking about that DST though....

eddy20

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Re: 1031 Exchange or just pay the tax and be done?
« Reply #22 on: August 15, 2023, 09:00:10 PM »
DST sounds interesting, but the ones I talk with seem like you should get X% but it could actually be X%. I have decided to keep my properties since again the DST at least some of them sound like time shares, you need a roof, pool redone etc and fees can reaLLY LOWER YOUR ROI.

Dicey

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Re: 1031 Exchange or just pay the tax and be done?
« Reply #23 on: August 31, 2023, 04:46:38 PM »
We've just about decided that we'd be up for trading our 3 SFHs in a senior resort community for one duplex where we live. The problem is that we don't want to boot any of our elderly tenants, so we couldn't sell them all at once. Next issue is there isn't anything available to buy in our local area. I'm very concerned that we couldn't adhere to the rules of a 1031 exchange.

I have a decent working knowledge of how 1031 Exchanges work, but I can't see how we'd pull this off with such limited inventory and staggered selling times.

In the past, we've done slow renovations, put the properties on the market just before the 1 year mark, and paid the damn LTCG.