A 1031 Exchange (Tax-Deferred Exchange) is one of the most powerful tax deferral strategies remaining to investors and an effective wealth building tool. Thanks to the Internal Revenue Code 1031 a properly structured exchange allows an investor to sell an investment property, reinvest the proceeds in a new property, and defer all capital gain taxes. The tremendous increase in purchasing power generated by the tax savings, compounded with the advantages of leverage, allows a real estate investor to potentially purchase two to three times more real estate. Some valuable benefits are as follows.
A properly structured 1031 exchange provides real estate investors the opportunity to defer 100% of Federal and State capital gain taxes. This essentially equals an interest-free, no-term loan on taxes due until the property is sold for cash. Most often, the capital gain taxes are deferred for an indefinite period because many investors continue to exchange from one property to the next, dramatically increasing the value of their real estate investments with each exchange.
Debt leverage and income yield can be increased by replacing a property with a high equity position, or one that is “free and clear,” with a higher-priced and more productive property that can potentially appreciate in superior increments into the future. A larger property can produce more cash flow and provide greater depreciation benefits, which therefore increases an investor’s return on investment.
Investors have a number of opportunities for diversification through exchanges. One option is to diversify into another geographic region such as exchanging one apartment building in Anaheim, California for two additional apartments – one in Portland, Oregon and the other in Dallas, Texas. Another diversification alternative is acquiring a different property type, such as exchanging an apartment building for a retail shopping center or triple net leased investment property.
Apartment investors know the ongoing maintenance and management that comes with owning apartment buildings. These issues can be lessened by exchanging these properties for management free assets like single tenant triple net leased investments, for example, a free standing McDonald’s restaurant or a Walgreens. Exchanges into securitized real estate investments also provide management relief.
Often a number of family members inherit one large property and disagree about what they want to do with it. Some want to continue holding the investment and some desire to sell it for cash. By exchanging from one large property into several smaller properties, an investor can designate that, after their death, each heir receiving a different property that they can either hold or sell.
- Exchange from a fully depreciated property to higher valued property for a new depreciation schedule.
- Exchange from an already appreciated property, to a higher cash flowing property.
- Exchange from a cash flow property to a property with faster appreciation. For investors who do not need the cash flow but desire to build their estate.
- Exchange for a property or properties that may be easier to sell in the coming years.
- Exchange to meet location requirements. If you moved across the country or for an investor who simply wishes to invest in a different part of the county or state.
- Exchange to fit your lifestyle, for example, exchange for a property requiring less management in order to travel more.
- Exchange from several smaller rentals into a larger apartment building to consolidate the benefits of ownership and management, or exchange from a larger property to several smaller ones to divide an estate among children or for retirement reasons.
- Exchange to a property an investor can use in her own profession, for example, a doctor may exchange out of an apartment building into a medical building he can use for his practice.
- Exchange out of a partial interest in one property to a full interest in another.
- Exchange into a single family rental property that will initially be held for investment. At a later date (2 to 5 years) the investor may decide to move into the property, convert it into their primary residence and take advantage of the tax exclusion benefits available under IRC Section 121.
- Exchange into a rental property that is located in a growing geographic area of the country.
Investment Capital Real Estate has built a sophisticated team of professional intermediaries (1031 Exchange Accommodators), tax advisors, and legal advisors to assist in your 1031 Exchange. We will guide you, step by step, though the exchange process, from the sale of your relinquished property and into your replacement property. Contact us to set up a consultation to review your portfolio and determine how your specific situation can capitalize on some of these key benefits listed above.
1031 Exchange Rules
Titles Must Be Identical
The vesting on title cannot change. The owner of the relinquished property must be the owner of the replacement property.
All Proceeds Must Be Reinvested
All profits and proceeds from the sale of the relinquished property must be reinvested. Any proceeds not reinvested may be subject to capital gains taxes.
Properties Must Be "Like Kind"
Your replacement property must be held for “business or invesment purposes”. You can exchange a few properties for one (or vice versa) or exchange residential for commercial (or vice versa).