Benefits of a 1031 Exchange
Top Ten Reasons to do a 1031 Exchange
1. Defer Capital Gains Taxes on the Sale
The main reason real estate investors do a 1031 exchange is to not pay tax on the sale, and use that cash as equity in the new property, a wealth building technique. In this manner, the tax is “deferred” until sometime in the future when the new property is sold down the road. It is important to note that a tax deferral is not the same as a tax exclusion, such as when you sell your principal residence.
2. Increase Cash Flow
Many investors are holding appreciated land or other non-income producing real estate and are looking to exchange it for income producing residential or commercial property. This increases cash flow and enables them to live a better lifestyle especially as they head into retirement years.
3. Increase Basis for Fully Depreciated Assets
Investors holding onto investment property for extended time periods run out of depreciation expense when the asset matures to its full useful life for tax purposes. By doing a 1031 exchange, the investor has the potential to restore basis and start the life of a depreciable asset all over again.
4. Exchange, then Convert to Primary Residence = Zero Tax!
One of the more popular tax free strategies available to American Homeowners is done through a 1031 exchange. First, 1031 exchange your old investment property for a new one. Then rent out the new one for two (2) years as required by a new safe harbor ruling, Rev. Proc. 2008-16. After two years, you move into the new property and convert it to a primary residence, live there for three (3) more years, then sell it. The gain that was rolled into the new property from the previous 1031 exchange gets eliminated by the principal residence exclusion under section 121 of the IRC, which allows you to exclude up to $250,000 of the gain from tax if your single, or $500,000 if you’re married. This is a perfectly legal, in fact encouraged, strategy as outlined by the IRS under Rev. Proc. 2005-14. There may be some tax due on the time you held the property as investment property as there is a proration required of the investment portion. However it is still a great strategy you can easily employ to reduce your tax bill down the road!
5. Greater Leverage Capability to Diversify Your Portfolio
Every smart investor knows NOT to keep all your eggs in one basket. If you’re holding onto highly appreciated property, you can leverage that equity by doing a 1031 exchange into two or more properties. This creates a diversified real estate investment portfolio used to hedge against losses in value of other investments due to location or economic downturns.
6. Eliminate Day to Day Management Headaches
If you have accumulated many rental properties over the years, you know what a pain it is to manage them all. The good thing is they have appreciated in value, and now may be time to sell. You can exchange those properties into one property by consolidating. You rid yourself of those nasty tenant phone calls and free up your time without paying tax on the sale of your old investment properties. Call us for more information on how to structure one of these exchanges.
7. Exchange into a NNN Managed Investment Asset
It is often difficult in the short 45-day time frame of 1031 to locate property that has the right price, financing and closing schedule to meet the strict exchange deadlines. A “triple net” (NNN) investment is real property that has a long term tenant in place, usually with a high credit grade such as a Walgreens or CVS, that qualifies as replacement property for 1031 exchanges and provides steady cash flow without the hassle of managing the property. The tenant takes care of the maintenance, taxes and insurance while you collect the rent. They provide investors with access to larger, institutional grade properties that have a number of advantages. As with any real estate investment, there are also risks involved. To learn more about NNN’s, give us a call and we’ll fill you in on all the details.
8. No more Absentee Landlord
Often people move or relocate, and their real estate investments need to move with them as being an absentee landlord has clear disadvantages. By exchanging your real estate investments to a location closer to where you live, you can manage them more efficiently without paying taxes on the sale.
9. Estate Planning
With a 1031 exchange, you can carefully tackle estate tax issues by adding your children or other beneficiaries on title to replacement properties when you exchange. Through this method you will eliminate most, if not all, of the estate taxes due on the passing of the owner, as the value of the estate would have been shifted to the beneficiaries prior to the date of death
10. Foreigners can avoid the 15% FIRPTA withholding tax in a 1031 exchange!
1031 exchange is not just for U.S. citizens, as foreigners can also enjoy the benefits of a 1031 exchange, i.e. sell their U.S. Real Property Interests (USRPI) and not pay tax on the sale, as long as they follow the 6 rules of a 1031 exchange. One of the show stoppers when a foreigner sells their USRPI is the mighty FIRPTA tax. This tax is actually a withholding tax based on 15% of the gross selling price of the USRPI. The final tax is determined when the foreigner files their tax return in the following year and then claims their refund once the final tax is deducted from the 15% withheld. 1031 exchange is an exception to the FIRPTA and can be obtained when the foreigner applies for a withholding certificate on IRS form 8288-B before the sale. It takes a few weeks to get approved, but it is a much better method to get the 15% back now, rather than wait a year or more to wait to file a tax return. See our foreigner’s section of this website for more information on this benefit.
Give us a call if one of the above situations appeals to you, or perhaps your own unique situation, and we’ll work together to design an exchange that’s right for you!