When and Why to Use a 1031 Exchange
Section 1031 of the IRS code provides a way for investors to defer paying taxes on gains when they sell one investment property and replace it with another. Yet IRS data indicates that less than 3% of investment property sales involve this powerful strategy.
Why???
Many investors simply do not have the information they need to make an informed decision regarding this tax efficient means to build a real estate portfolio. The 1031 Exchange allows the investor to sell and buy real estate while deferring payment of the capital gains tax and use those same tax dollars as additional leverage for the next investment purchase. It is a legal and IRS sanctioned way to keep investment dollars working for the benefit of the investor.
There are many solid business, lifestyle and estate planning reasons to move from one investment property to another:
- Leverage into a larger property
- Reallocate an investment property portfolio without creating a taxable event
- Transition from passive land investment to active rental property
- Transition from single family to multi-family rental properties
- Move from residential property to commercial or industrial property and vice-versa
- Transition a vacation rental property from one location to another
- Move from an area of low equity growth to one of high equity growth
- Transfer property to heirs without creating a taxable event
- Leverage an investment in a vacation/rental property that may eventually become a retirement home with the opportunity to not just defer but eliminate the tax
While 1031 Exchanges are form driven with specific requirements, in most of the scenarios outlined above investors simply need to abide by a few basic rules to take advantage of this option. An experienced 1031 Exchange qualified intermediary guides investors through the process and creates the documentation required to defend the exchange should an IRS audit occur. While it may seem too good to be true, it is possible to sell your investment property and roll all the gain to a new property without paying any tax.
Sources:
National Association of Realtors, https://www.realtor.org/presentations/webinar-2013-investment-and-vacation-home-buyers-survey
Internal Revenue Service, Statistics of Income Division, https://www.irs.gov/uac/SOI-Tax-Stats-Business-Tax-Statistics, Form 8824