Often referred to as a Starker Exchange or Like-Kind Exchange, a 1031 Exchange is a strategy utilized by many of the most prominent real estate investors in the country. Fortunately, you don’t have to be a multimillion-dollar investor to take advantage of a 1031 Exchange. If you have ever been interested in investing in real estate or exchanging properties for cash, now may be the perfect time to consider doing a 1031.
What is a 1031 Exchange?
Defined under section 1031 of the IRS Code, a 1031 Exchange allows a real estate investor to defer payments on capital gains taxes on a property during a sale as long as the investor purchases another “like-kind property” with the profits from the sale. A 1031 exchange allows individuals and businesses to move their investments around without having to worry about tax liability. It can also help investors who wish to change the type of properties they typically invest in without having to pay an enormous sum of taxes.
Taxes and 1031 Exchanges
As many investors know, selling the wrong investment property can be expensive. Sellers are often on the hook for capital gains tax, even if they weren’t the ones who initially purchased the property. However, if you currently own a property that has significantly appreciated over the years, you may be in the position to do a 1031 exchange.
Although you will eventually need to cash out and pay taxes, performing a 1031 Exchange can help you temporarily defer capital gains taxes. To benefit from the tax law, your new loan amount must be equal to or greater than the original loan amount.
Types of Exchanges
In general, there are four different types of exchanges:
- Simultaneous Exchange – When both the replacement and relinquished property close on the same day “simultaneously.” It is important to note, however, even a brief delay between the closure of both properties can result in the disqualification of the exchange.
- Delayed Exchange – The property originally owned by the investor is transferred first and the property the investor wishes to purchase is acquired afterwards.
- Reverse Exchange – A reverse exchange occurs when the investor buys a replacement property before selling the property that they wish to replace.
- Construction (Improvement) Exchange – A construction exchange allows investors to make improvements on a replacement property using the exchange equity.
Although delayed exchanges are the most common, one of the other types of exchanges may be better for your venture.
A Wealth of Benefits
Overall, a 1031 Exchange can provide you with a wealth of financial benefits. By carefully choosing and utilizing 1031 properties, you can greatly increase your real estate investment returns.