The Real Estate Investment Benefits of a 1031 Exchange

An IRC Section 1031 tax-deferred exchange (or simply “1031 exchange” for short) is an important tax strategy to understand if you own investment real estate or real estate for business purposes. It can be utilized for any non-owner-occupied property, including commercial real estate, residential units and raw land. Most properties you buy and sell for investment reasons are eligible for a 1031 exchange.

What is a 1031 Exchange?

An IRC 1031 exchange enables an owner of real estate to defer capital gains taxes that would normally be due upon the sale of the property. The investor can reinvest funds earned from a sale into a new business or investment property. The sale and purchase are conducted like any other real estate transaction. However, a Qualified Intermediary must be involved to structure the 1031.

One often-misunderstood aspect of 1031 exchanges is the fact that the IRS requires the tax payer to reinvest in “like-kind” real estate. Many mistakenly interpret this as meaning you have to buy a very similar type of real property. That isn’t actually the case. As long as the new real estate is being held for productive use in a trade or business—or for investment purposes—it should be eligible. Quick property flips are generally not allowed and there are some other rules you will want to know before you execute a 1031 exchange for tax deferral reasons. Just know that the “like-kind” fine print may not be as strict as you think it is.

1031 Exchange Benefits

There are a number of benefits associated with 1031 exchanges:

Tax Deferral

This is the obvious advantage. You can defer your capital gains taxes on a real estate sale by completing an eligible 1031 exchange. This may be beneficial to you unless you need the proceeds from your real estate sale for other purposes. Simply reinvest it into something more suitable and avoid paying those capital gains.

Diversification

Real estate is just like any other investment portfolio. Diversification can make a very positive difference over the long run. 1031 exchanges and other real estate investment strategies can help you build a more diverse property portfolio that provides long-term benefits.

Changing Investment Plan

1031 exchanges can allow you to dump unwanted investment or business properties and purchase others that fit your financial plan. You could move from a labor-intensive rental unit to something else that makes just as much money, but takes up much less of your time. As your investment plan involves, 1031 exchanges can help you transition into different real estate opportunities.

Relocation

You may be looking to move to a new area or wanting to invest in a different location. A successful 1031 exchange enables this relocation from one investment market to another.

Consolidation

You may utilize 1031 exchanges to consolidate multiple investment properties into one bigger investment. This can get more complicated to execute, but it may be an effective consolidation strategy.

Leveraging Equity

A 1031 exchange gives you a way to leverage the equity from one property sale into a new investment without having to pay capital gains taxes. This offers more buying power and investment potential.

Your Wealth Management Partner

To learn more about 1031 exchanges and for help with managing your real estate investment portfolio, contact the team at Illumination Wealth today. Let us help you make the most of your wealth management plan.