1031 Exchanges are a Real Estate Investor’s Secret Weapon

Contributed By

AdvantaIRA banner

Author: Theresa Knower, COO, CISP

Author: Theresa Knower, COO, CISP

In the ever-changing real estate market, it is important to stay on top of what options are available to you when it comes to real estate investing.  There are tax strategies that are geared specifically for the savvy real estate investor.  These strategies allow you to diversify your portfolio while deferring capital gains taxes.

One such strategy is the 1031 Exchange.  A 1031 exchange allows you to sell a piece of investment real estate and defer the capital gains taxes by purchasing another piece of investment real estate of equal or greater value.  As you already know, long-term capital gains are 15% for properties held for more than 1 year.  (This rate could potentially increase in the coming months)  However, the majority of investors do not take into consideration that some states may have a state income tax ranging from 4% to 7%, and that there is also a recapture tax of 25% for any depreciation taken on the investment property.  A 1031 exchange allows you to avoid all of these taxes.  It gives you more leverage when you are ready to purchase your next property because 100% of the proceeds are rolled over rather than what is left after taxes.

The possibilities are virtually endless.  Let’s say you have an office building that just isn’t serving your needs.  You want to expand to a larger income-producing property.  By doing a 1031 exchange, you can sell your current building, and roll those proceeds over into a larger commercial building that will produce more income.  Another option would be to sell your current unit, and purchase several units, thus allowing you to expand your practice into more locations.  Today’s market is flooded with opportunities for you to purchase buildings that were once thought to be out of your range.

With the current market, another option that has grown in popularity is the Reverse 1031 Exchange.  This strategy allows you to purchase your replacement property prior to selling the property that you currently own.

This may sound like a complicated endeavor, but in actuality, it is pretty simple.  There are some basic rules that you should be aware of when doing an exchange.  First and foremost, it is always recommended that you consult your tax advisor before making any decisions.

Once you have determined that a 1031 exchange is the best option for you, it is important to keep in mind the following rules:

  1. All properties involved in the exchange must be investment property.  They cannot be your primary home or second home.
  2. The net sales price of your relinquished property is the amount that must be invested in the new property in order to defer all capital gains.  (ContractSalePrice – Realtor Fees/Closing Costs = Net Sales Price)
  3. You must use a Qualified Intermediary to facilitate the exchange.  It must be an independent third party, which means that it cannot be your accountant, attorney or realtor).
  4. You have 45 days from closing on your sale to identify up to 3 possible replacement properties.  You can identify more than 3, but there will be restrictions imposed.
  5. You have 180 days from closing on your sale to complete your exchange.

As you can see, these rules are simple and straightforward.  The IRS is very strict on these rules.  There are no exceptions. No one knows what the future holds.  Now is the time to take your financial future into your own hands.

Leave a Comment