If you’re thinking about selling off one of your rental properties, you should be aware that doing so can leave you with a massive tax bill, thanks to capital gains taxes. If you sell an asset for more than you purchased it, the government collects a tax on that gain, which can be upwards of thousands of dollars. But with a 1031 exchange, you can buy a new property and defer those taxes entirely!
So today, we’re going to dive deep into what a 1031 exchange is, how it works, and how you can find out if this strategy is a good fit for you. Click play to learn more about how you can save money with a 1031 exchange.
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Here’s how a 1031 exchange works:
To do a 1031 exchange, you’ll need to work with a qualified intermediary who can walk you through the process.
In order to qualify for a 1031 exchange, the properties involved in the exchange must be held for either business or investment purposes. Because I someone will ask – no, you cannot conduct a 1031 exchange on your primary residence. The IRS will request that you prove that your property is an investment via tax returns and records of rental income.
Your new purchase (also called the replacement property) must meet some requirements as well. This means if you want to defer all taxes, the replacement property must be of equal or greater value than the property that was sold.
The replacement property must be like-kind. In my experience, this term causes a lot of confusion investors. It’s a broad guideline that refers more to the nature of the investment than the actual type or quality. For the most part, any piece of real estate will qualify as like-kind. For example, if you sell a single-family home, you don’t necessarily have to purchase another single family. You could exchange for a duplex or triplex, a warehouse, or an office space. The exception would be anything that isn’t a long term investment, such as properties used for flipping. The replacement property also must be in the US.
Important! If you take away one thing from this video, let it be this: the 1031 exchange involves strict guidelines! This process is not something you can do in a leisurely manner. There are two important numbers to remember in order to have a successful transaction: 45 & 180. The IRS requires that the investor identify their purchasing plans on day 45 of the exchange AND the investor has 180 days to complete the exchange and close on the replacement property. The 45 day timeline and the 180 timeline run simultaneously, and the clock starts on the day escrow closes on the sale of the first property (also known as the relinquished property). These are strict guidelines, and the investor must meet both time limits. If you fail to identify replacement properties by day 45, or do not purchase your replacement within 180 days, you can expect to be taxed on the sale of your property. There are no exceptions or extensions to these timelines. For more on these guidelines, you can check out my full blog post.
The main reasons why you might consider a 1031 exchange in 2023:
Appreciation. There’s a good chance that a majority of your portfolio has seen healthy appreciation over the past few years. That makes now a great time to take advantage of the 1031 exchange. It’s a great opportunity to preserve your equity, keep the proceeds you would have paid in taxes, and instead use those funds to buy better performing properties.
Cash flow. Let’s be honest, sometimes you scoop up a property and it’s a dud. I know this has happened to me. Instead of selling off that investment and taking the tax hit, you can exchange it for a property in a better market with higher cash flow.
Diversification. As long as your replacement property is used for business or investment purposes, you can use a 1031 exchange to diversify your portfolio.
Wealth preservation & estate planning. When you clicked on this video, I bet you weren’t expecting to think about your mortality, so let’s make this brief: using a 1031 exchange is a great estate planning tool because it allows your estate to inherit your assets, and if your heirs decide to sell those properties, there would be no capital gains taxes for them.
What type of investor might consider a 1031 exchange?
Interested in learning how to avoid capital gains tax
Looking to purchase performing assets in top growth markets in exchange for current portfolio
Interested in making a switch from commercial to residential real estate
Seeking investments that will offer a better return on investment and wish to diversify
Interested in exchanging an investment property that you currently manage for a more “hands off” investment opportunity
I also want to note that even if you’re not actively considering selling a rental property, it’s always wise to evaluate the health of your portfolio. If you haven’t taken a good look at the performance of your properties lately, you may want to consider using a 1031 exchange.
At Morris Invest, we’d be happy to talk to you about your goals and help you determine if a 1031 exchange would be beneficial for you. Our 1031 exchange program makes the entire process quick and easy.
If you’re looking for ways to save taxes and are considering selling a property, we can help you buy new construction real estate in America’s best rental markets. To schedule a free call, go to morrisinvest.com
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DISCLAIMER: I am not a financial adviser. I only express my opinion based on my experience. Your experience may be different. These videos are for educational and inspirational purposes only. Investing of any kind involves risk. While it is possible to minimize risk, your investments are solely your responsibility. It is imperative that you conduct your own research. There is no guarantee of gains or losses on investments.
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