What is a 1031 Exchange?
A 1031 exchange also known as a tax deferred exchange is when a seller of real property defers paying taxes on their Capital Gains (profit) by reinvesting those earnings following specific IRS rules and timelines.
Graphic and example from IPX 1031 -a Fidelity National Financial Company - Fortune 500
Graphic and example from IPX 1031 -a Fidelity National Financial Company - a Fortune 500 company.
If you sell a property that you own as an investment you are subject to paying state or federal taxes on the profit you earned based on your tax bracket and state the property and you reside in.* In some cases it can be more than 40% of your profit. This is a big tax hit and deters many owners from selling a property. A 1031 exchange, named after it’s IRS code, allows you to defer those taxes if you reinvest the profit in another 1-3 properties you’ve identified and purchased within a specific timeframe.
These are 3 of the most common ways to grow a real estate portfolio. Which is the most efficient?
Save rental income for the next investment.
Refinance a current property and use the equity to invest in another property.
Use all the equity in a property by selling a property and rolling over the profit to purchase up to 3 replacement properties.
According to irs.gov
What are the benefits of executing a 1031 Exchange?
Defers taxes on profit made (capital gains)
Allows profit to compound and grow real estate portfolio
Decrease investment risk with portfolio diversity in location and product type
Increase Investment Income
Estate Planning
What are the Rules of a 1031 Exchange?
Like-Kind property- Must exchange from real estate to real estate for investment. (cannot exchange personal residence)
You can identify up to 3 properties as your replacement property totaling more than what you sold your property for
You must identify these properties within 45 days of close of escrow of your sold property
You must complete the purchase within 180 days of close of escrow of your sold property
Overall, executing a 1031 exchange is a great way to rebalance a real estate portfolio to meet different investment goals. An investor may be looking to consolidate smaller properties into one larger property for ease of management and economies of scale. With a larger building they can afford an onsite manager or management company to oversee the property and give them more time. An investor may diversify a portfolio by selling one type of property in order to exchange into another market. An investor may complete a 1031 exchange to rebalance equity and increase cash flow. Another investor may be retiring and sell their property where they had their business to exchange into a property to preserve capital like a grocery anchored shopping center. Another investor might exchange into single tenant lease property with a corporate tenant to no longer have management responsibilities but have reliable income and no management responsibilities.
Lets discuss your goals and how we can help you with your real estate investment business plan.
Complimentary 1031 Exchange Report
Includes: Return On Equity Analysis | Cash Flow Projections: 1 year, 3 Year, 5 Year, 10 Year | Targeted Upleg Property Search