What is A 1031 Exchange?
In real estate, a 1031 exchange is a swap of one investment property for another that allows capital gains taxes to be deferred. The term, gets its name from the Internal Revenue Service (IRS) code Section 1031.
In effect, you can change the form of your investment without (as the IRS sees it) cashing out or recognizing a capital gain. That allows your investment to continue to grow tax-deferred.
Under Section 1031 of the Internal Revenue Code like-kind exchanges are “when you exchange real property used for business or held as an investment solely for other business or investment property that is the same type or ‘like-kind’.” This strategy has been permitted under the Internal Revenue Code since 1921, when Congress passed a statute to avoid taxation of ongoing investments in property and also to encourage active reinvestment.
When You Want a 1031 Exchange
As an investor, there are a number of reasons why you may consider utilizing a 1031 exchange. Some of those reasons include:
You may be seeking a property that has better return prospects or may wish to diversify assets.
If you are the owner of investment real estate, you might be looking for a managed property rather than managing one yourself.
You might want to consolidate several properties into one, for purposes of estate planning, for example, or you might want to divide a single property into several assets.
Reset the depreciation clock (explained below)
The main benefit of carrying out a 1031 exchange rather than simply selling one property and buying another is the tax deferral. A 1031 exchange allows you to defer capital gains tax, thus freeing more capital for investment in the replacement property.
It’s important to keep in mind, though, that a 1031 exchange may require a comparatively high minimum investment and holding time. This makes these transactions more ideal for individuals with a higher net worth. And, due to their complexity, 1031 exchange transactions should be handled by professionals.
In Conclusion…
A 1031 exchange can be used by savvy real estate investors as a tax-deferred strategy to build wealth. The many, complex moving parts not only require understanding the rules, but also enlisting professional help – even for seasoned investors.
If you need help with a 1031 Exchange, contact us and we’ll walk you through every step of the process.