As the market changes over time, so do your investment needs. You may need more diversification, increased cash flow, or less management responsibilities. But every time you trade a property, the IRS takes a cut and your portfolio value is diluted.
There is one tool that pros use to defer capital gains and reinvest 100% of their cash, quickly growing their portfolio.
A 1031 Exchange allows you to sell your property and invest 100% of the sale price into the investment of a like-kind replacement property. You can roll one property into another, with no limit on how many times you can exchange property. Taxes are deferred until you eventually sell the property for cash.
Benefits of a 1031 Exchange include:
Tax Deferral – 100% of the funds from the sale of your property are used to purchase a replacement property.
Diversification – You can sell a property and diversify your portfolio into several replacement properties.
Consolidation – You can sell multiple properties and consolidate the funds into one replacement property.
Increase Cash Flow – You can sell a property that produces little or no cash flow (such as land) and exchange it for an income-producing property (such as a retail shopping center).
Management Relief – You can sell a high-maintenance property and reinvest the proceeds into a triple net leased investment requiring no management responsibilities.
In a 1031 Exchange, all of the debt and equity must be reinvested to defer all taxes. The purchase price of the replacement property must be equal to or greater than the sale price of the relinquished property. You can always add more cash to the purchase of your replacement property. But, if you pull any money out, you are subject to tax liabilities, called a “boot”.
A 1031 Exchange allows you to exchange one like-kind property for another. The like-kind definition is surprising broad. Any real estate held for investment is considered like-kind. For example, you can swap an apartment building for a retail shopping center.
Your primary residence, however, is excluded from a 1031 Exchange. You cannot swap your personal residence.
The most common type of exchange is a Forward, or Delayed 1031 Exchange. First, your property is sold and the cash is held by a Qualified Intermediary. Second, you identify a replacement property. Third, your Qualified Intermediary buys the replacement property for you.
There are two timing rules that must be followed in a 1031 Exchange.
45 Days – Once your property closes, you have 45 calendar days to specify a replacement property. You can designate more than one property, as long as you close on one of them.
180 Days – You must close on your replacement property within 180 days of the closing of your old property. The 45 days and 180 days run currently.
A 1031 Exchange must be structured properly, generally with the assistance of a Qualified Intermediary. The Qualified Intermediary prepares the legal documents and ensures compliance with all laws, regulations and rulings.
What have you found to be the biggest advantages to a 1031 Exchange?