The 1031 tax deferred exchange has always been popular, however, since the real estate decline about a decade ago there was less desire to sell existing investment property. Upgrading to better property with declining values obviously had no merit. Now with the real estate market running full steam ahead and value of properties going upward, the benefit of a 1031 exchange is becoming a very popular tool once again.
Lately, I have been getting asked a lot about 1031 tax deferred exchanges. New investors especially want to know what exactly it is, and why everyone is talking about it now. Repeated questions on a topic suggests a post on the topic has merit.
So what is this 1031 Tax Deferred Exchange?
As many savvy investors will share with you, a 1031 Exchange is a vehicle that allows you to sell an investment and defer the capital gains taxes. Simply stated, it allows you to roll over the capital gains (which you would ordinarily pay taxes on) into the next investment.
Needless to say, there are rules and restrictions around how you must do this, but when done correctly allows you to build up a great amount of equity growth and continue to trade up to bigger and better investments. See 1031 rules and guidelines at Internal revenue code section 1031.
Why is everyone talking about it now?
I can appreciate why this questions has arisen as you have not heard much about 1031 exchanges in the past few years. As you understand and internalize what a 1031 exchange is used for, the reason for it being quiet lately and now earning more attention will make sense.
Investors tend to sell their investments when they can get top dollar for them and then they like to reposition that asset into the next great deal or the next emerging market.
Since the real estate market has bottomed out and prices are rebounding, it once again makes sense to trade up to better performing assets or perhaps a different asset class.
Now that prices have been rising and they are able to sell their earlier purchased properties for a nice gain, the need to defer the taxes on that gain has once again surfaced.
What are seasoned investors trading up to?
Emerging markets: Markets within the country are positioned differently. Some are at the beginning stage of a buyer’s’ market while others are becoming sellers markets. As markets climb in one part of the country toward a seller’s’ market, there are other parts of the country that are just beginning their growth stage (the buyers market). It makes great sense to sell their higher priced properties that have already realized a gain and now approaching a seller’s’ market and reposition into the next growth (buyers market).
Trading into different investment classes: Some people who currently own single family homes are trading into larger multi-family homes and vice versa. As the number one choice by tenants lately has been single family homes, we now are seeing people selling their duplexes, triplexes and fourplexes and investing in these highly sought after single family houses. The nice thing about 1031 exchanges is there are not really restrictions on how much the investment costs as long as you spend equal to or better than the amount of the exchange. For example if you sell a $200,000 duplex and buy 2, $100,000 single family houses you are good, you just want to be sure you spend all $200,000 to realize the full deferment.
Variety of investments: Of course these 1031 exchanges are not limited to just real estate. I have heard of people who invest in horse racing and their horses are being exchanged. The trade must be considered a LIKE KIND exchange, but is not limited to real estate.
As long as they are investments that get exchanged into a similar like kind of investment and the proper rules are followed, you can exchange. The key thing to remember is to follow the rules as written. There are no exceptions to the rules, but following them have the ability to save you thousands in tax deferment.
Trade up and escalate your investment portfolio
If you have owned an investment for a period of time and have a hunch that there may be better investments available for your investment dollar, I strongly encourage you to look into the viability of doing an exchange and accelerate your investments forward.
We are happy to discuss this with you. If you would like to contact us we can strategize what may work best for you.