What is a 1031 exchange? The term comes from U.S. Tax Code section 1031, which allows owners of specified types of assets to defer capital gains taxes on an exchange of similar properties.
What does this mean for you? As an investor, you can sell a property to reinvest the proceeds in a new property and defer all capital gain taxes. Just remember, this transaction defers taxes, but it's not tax-free. There are also time limitations and other specifics that you definitely want to discuss with an experienced realtor, but still, that's a pretty sweet deal, right?
Yes, actually, it is. So it's a wonder why more people aren't taking advantage of such a transaction. Let's take a look at the pros and cons so that you're better equipped to decide whether or not a 1031 exchange is for you:
Deferring taxes means you have more money upfront — that means you can essentially exchange your investment property for an even greater investment property.
This gives you an opportunity for investment properties that are more aligned with your current needs — maybe you purchased a property 10 years ago but the location is harder to get to for you now, or upkeep is costing more than you'd like. This is an opportunity to find an investment that reflects your life now, not what it was 10 years ago.
Many investors regularly perform 1031 exchanges because, when done right, they are an amazing tool to help you build wealth and expand your investments.
Limitations, paperwork, regulations. A 1031 exchange is a great opportunity, but it's not a free-for-all. You want to ensure that you're working with a knowledgable and experienced realtor (like Shakeh Grigor) because there are a lot of details, procedures, and regulations that will need your attention.
Remember that a 1031 exchange is not tax free, it's tax deferred.
The new investment property will experience reduced tax basis. So if you end up selling your new investment property, you will be taxed on the deferred gain.
There are also regulations on losses that can be recognized when you're filing taxes.
That's a lot of information, but hopefully it helps you think about whether or not a 1031 exchange is for you. This isn't legal or financial advice so you definitely want to reach out to a professional, like a CPA, before you make a final decision.
As always, Shakeh Grigor, is available and happy to discuss any of your 1031 exchange questions in terms of real estate.