Death and taxes – these are the only two things that are guaranteed in this world. But what if there was a way for you to defer taxes as a real estate investor?
In today’s conversation, Margo McDonell, President and CEO of 1031 Corp, joins us to explain how you can take advantage of a 1031 exchange as a real estate investor. It’s more than just not having to pay the taxes, there are a lot more reasons why you might want to start looking into this great long-term strategy!
Here are some power takeaways from today’s conversation:
- Why a 1031 exchange is important
- Other benefits of a 1031 aside from the tax break
- Things to consider when doing a 1031 exchange
- How depreciation recapture is factored into the exchange
- Possible roadblocks when doing 1031 transactions
Episode Highlights:
[03:37] The Importance of a 1031 Exchange
A 1031 exchange is a tax break that allows for a real estate investor to sell a property and replace it with another one that works better for them. They then get to defer the federal capital gains, the state income tax, and the depreciation recapture. Using the 1031, they can grow their real estate portfolio with pre-tax dollars.
[04:09] The Multiple Advantages of a 1031 Exchange
A 1031 exchange has so many advantages beyond just the tax break, such as being able to buy something that works better for you or something that generates greater cash flow or that’s easier to manage. It’s a great long-term investment strategy and a great exit strategy. You can sell your business and sell the real estate attached to it and then use that as a steady cash flow for you in retirement. You can acquire a rental property in a resort area, and when you’re ready to retire, use it as a second home or primary residence.
The IRS code allows the seller of the real estate to not pay a significant potential portion of taxes due. For instance, you can sell a single-family rental to buy a multifamily. You could sell that piece of vacant land that you bought, and you were going to build something on and you never did. And exchange that for three single-family rentals that are going to bring in cash flow for you. Or you could sell 10 single-family rentals, individually or as a package, then take all the proceeds from all of those properties without paying any federal or state taxes, and roll it all into that 30-unit apartment building that you’ve been wanting.
[10:55] Things to Consider When Doing a 1031 Exchange
When you do a 1031 exchange, you have 45 days to identify the new property from the day you sell your first property. At the same time, you have 180 days to buy the new property. Regardless of what the real estate market is doing at the time, be sure to plan ahead and really look for that property. Try to line up that replacement property so you’re ready to go. If you’re selling multiple properties, timing is definitely the trickiest part of that transaction, unless you package them and sell them all together, which is what most investors do.
The 1031 exchange also does not work when you’re buying from a related party, unless the related party is also doing a 1031 exchange, or if the related party pays tax, and they pay more tax than you would have paid without the 1031 exchange.
Now, when you pass away, your heirs inherit everything through a Stepped-Up Basis, meaning all the gain is deferred at that point in time. And depending on the size of your estate, you may or may not have estate taxes. Hence, it’s also a very powerful wealth accumulation strategy.
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