The 1031 exchange is a popular term for real estate investors. It is actually called the 1031 tax deferred exchange. It is vital that the beginning real estate investor understand this technique to increase your profit potential in property investing.
The benefit to the 1031 exchange is that if you sell an investment property at a profit and you have capital gains, instead of paying your capital gains taxes, you can put that money toward another investment property. Delaying paying those taxes equal more profit and increased wealth for you. The government knows they will get money eventually and if you use the 1031 exchange, they will get even more. The government will be happy if you take advantage of this technique.
There are a few things to remember in order to use the 1031 exchange. If you sold an investment property, you have to purchase another investment property. Selling an investment property and using the capital gains to buy a home for personal use is not allowed. So remember, you can buy another investment property but not a personal residence.
You cannot use the 1031 exchange to buy an investment property that is lower in value. It must be equal to or greater than the property that you have sold.
There also can be no additional money given to you to use the 1031 exchange. For instance, you can’t use it if you buy a property that comes with something else of value….like the property and cash to sweeten the deal.
Types of 1031 tax deferred exchange
There are a few different types of 1031 exchanges. You have the straight exchange. It is as simple as it sounds. You basically trade properties of equal value with another investor. This does not happen often since it is difficult to meet the equal or great than requirement.
The 3 part exchange is used more often. 3 investors are involved in this deal. One thing to remember is that the investor that is going up in value can never actually have equity in the property that is traded. He can sell his property, collect the profits and go buy a bigger investment property. It doesn’t make sense to trade to a smaller property so things have to work out for everyone involved so that everything comes out equally. This is a very complicated technique to explain. There are a few 1031 exchange websites out there that can explain how the different exchanges work.
Another type of 1031 exchange is the delayed exchange. I don’t know much about this type of exchange. Basically the delayed exchange is when the titles to the properties do not have to be given at the same time. There are other details about this type of exchange that I have not mentioned. There are time tables involved with this exchange. Investors have time limits to get all the paperwork and the exchange of properties must be completed within a certain time frame. The delayed exchange gets really complicated, too complicated for me to explain. This is yet another situation in which you should consult with both your accountant and attorney.
The key with the 1031 delayed exchange….don’t miss the deadlines given, otherwise capital gains taxes will be due.
REMEMBER
The 1031 exchanges and depreciation don’t mean that you never have to pay your capital gains taxes. It just means that you can pay the taxes later on.
