Part 5 - 1031 Exchanges
Not only can you depreciate rental properties to save on taxes, but a 1031 exchange allows you to sell a rental property and defer the taxes on any profit you make or recaptured depreciation.
Typically when you sell appreciated investment real estate you must pay federal income tax on the property’s gains sometimes as high as 20%. A 1031 exchange allows you to exchange your properties as many times as you would like for a "like kind" property.
Accumulate Wealth
Real Estate has and still is a powerful vehicle for wealth accumulation due to being one of few asset classes that enjoy favorable tax treatment. Reducing your taxes is an important part of building your net worth and doing a 1031 exchange with one’s investment properties does just that!
Massive Tax Advantages
A 1031 exchange permits the investor also known as an exchanger to defer federal capital gains tax, depreciation recapture tax, investment income tax imposed by the Affordable Health Care Act and state tax. Tax avoidance and tax evasion are two very different things. Tax evasion is illegal and can lead to jail time. Tax avoidance is a smart lawful way to utilize one’s own assets to minimize tax liability. All 1031 rules must be followed in order to qualify.
Leverage More Cash for Reinvestment
Investors can take advantage of 1031 exchanges when acquiring a more valuable investment property. Investors can use the money that would have been paid to the government for tax purposes to make a larger down payment increasing their buying power to purchase a more expensive replacement investment property.
Diversification and Consolidation of Assets
A property investor may exchange one property for several other properties, diversifying their assets. For instance exchanging an office building for several homes or exchanging their investment house California for a ski condo in Colorado and a cabin on a lake in Minnesota. A property investor may also exchange multiple properties for one property, consolidating their assets. Remember, 1031 exchanges can only be used on properties within the United States.
Management Relief
Owning and managing several rental properties such as several homes in a college town or desirable vacation destination can take a great deal of time. From the many nuances of managing individual rental contracts and tenants to property upkeep, and regular as well as unexpected maintenance costs. Investors who are over the headache and time it takes to manage these types of investment can exchange their homes for one apartment building or a commercial building offering NNN leases to its business tenants.
Estate Planning
Capital gains taxes are eliminated upon the death of the property owner. Heirs receive a step up in basis on the date of death meaning your heirs get the property at its value on the date of your death without incurring taxes.
Potential to Increase Cash Flow and Income
A vacant parcel of land that is not rented, therefore generates no cash flow, could be exchanged for a property that generates income, such as a rental home, multiplex residential rental property, strip mall or other kind of commercial building.
Are you looking for a way to invest or do you already own investment properties? If so utilizing a 1031 exchange might be just the right investment for you! Be sure to consult your financial advisor and make sure you meet all of the rules and regulations tied to 1031 exchanges first.
This is Part 5 of a 5 part series addressing 1031 exchanges. Please visit my other blogs for more information on 1031 Exchanges:
Part 1 - What is a 1031 Exchange?
Part 2 - 1031 Exchange Process
Part 3 - 1031 Exchange Rules
Part 4 - Types of 1031 Exchanges
If you are considering selling an investment property I highly recommend you speak to your financial advisor about the possible benefits a 1031 exchange could have for you. It’s also important to note that I am a real estate agent and not an accountant, a QI, or an attorney. Please seek legal and financial advice from those who are qualified.
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