Juli Doty - Real Estate, Real Advice

1031 Exchange

What is a 1031 Exchange?

Internal Revenue Code Section 1031 provides that no gain or loss will be recognized on the exchange of any type of business use or investment property for any other business use or investment property.

1031 Exchanges are not really exchanges in the context of two-party barter. Instead, they are typical sales and purchases that involve the same exact ingredients as any other sale or purchase, without the capital gains. The only real difference is the investor is increasing his selling and buying power by electing to avoid the drain of taxes under Section 1031 regulations. No other aspects of the transaction are affected.

Who Should Consider a 1031 Exchange?

Anyone who is thinking about selling a business use or investment property should consider affecting a 1031 Exchange.

An exchange offers the astute investor an opportunity to reinvest the federal capital gains that would normally be handed over to the IRS and put that money to work for himself.

You work too hard to simply pay the tax without carefully considering this reinvestment option. Essentially, 1031 Exchanges should be thought of as an interest free loan from the IRS; one in which the principal may be increased through subsequent exchanges and may never require repayment, if you plan properly.

Powers of Exchanging

1. The 1031 Exchanger will have increased buying power because the federal income taxes are deferred. This will enable you to leverage yourself up greater than you could have after paying the tax liability. The additional equity to reinvest will make you a more solid buyer and help you get easier financing.
2. Investors can do exchange after exchange to create a pyramiding effect. This tax liability is forgiven upon the death of the investor as the heirs get a stepped up basis on the inherited property.
3. The Exchanger will have greater selling power because you do not have to inflate the sales price to try to cover some of the capital gains that would normally be due upon the sale of an investment property. It will enable you to be more flexible with the selling price.
4. The Exchanger can acquire a replacement property with greater income potential. You can sell raw land and acquire income-producing property. Perhaps, you want to acquire a building with additional units or in an easier to rent location.
5. The Exchanger has the opportunity to consolidate several hard to manage properties in one easy to manage property or diversify several small properties into one large property. It provides an excellent opportunity to relocate or expand a current business or investment.
6. An exchange can also help you acquire a less management intense property.

1031 Exchanges Accomplish Tax Reduction, Plus!

1. Estate preservation
2. Increased buying power because of greater cash flow
3. Increased selling power because the federal capital gain tax liability is deferred
4. Exchange for property with an increased income (more rental units, higher rental income per unit, lower operating expenses, easier to rent location, etc.)
5. The need or desire to relocate a business or investment property
6. Exchange for property that requires less management
7. Exchange for property that is easier to finance
8. Consolidate smaller properties into a larger property
9. Diversify a large property into several smaller properties
10. The need or desire to expand a business into a larger space

All of the above culminates into the ability to create pyramiding wealth through real estate ownership.