JLM Blog | 1031 Exchange: Benefits and How to Use ItReal Estate News, Updates, and Tips
Real Estate Agency San Diego, CA
Article published on December 27, 2021
The 1031 Exchange is a tax and investment strategy, and it allows property owners to defer the capital gains taxes they would otherwise owe on the sale of their investment property. The 1031 Exchange is also called a like-kind exchange because the new property must be of like-kind to the property relinquished. This means that if you sell your rental property for cash as an investor, you can use Section 1031 to reinvest as a landlord by purchasing another rental property that meets these requirements.
To understand how this strategy works, take a look at some of its benefits and how to use it.
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Section 1031 and the 1031 Exchange
The FHA 203k loan is a mortgage program created by the Federal Housing Administration that allows low-income individuals to buy homes with very low down payments. If you are interested, you can use this loan to purchase a home that meets your needs. The main benefit of using this loan is that it offers an affordable way to own a property without having to meet FICO score requirements. However, the downside is that it limits how high the value of your property can go.
In order to take advantage of Section 1031 and the 1031 Exchange, you will need two separate properties: one as an investor and one as a landlord. When you sell your rental property for cash, you will invest in another like-kind property and then sell that second property in order to offset any capital gains taxes on the sale of your first investment property.
Now let’s dig into how this strategy works!
Defer the taxes your would have to pay on capital gains
Let’s say you bought your rental property for $100,000 in 2012. Right after the purchase, you would have faced a capital gains tax of 15 percent on the $85,000 profit from that sale. In this example, you would owe a total of $11,250 in taxes on the sale.
If instead of selling your investment property and paying the capital gains tax to Uncle Sam, you use Section 1031 to defer those taxes by investing (in like-kind) in a new rental property worth at least $100,000 with another taxpayer who is not an immediate family member. You can keep the original property and sell it next year when the gain is less than or equal to $100,000.
This way, you avoid paying that 15 percent capital gains tax while also avoiding paying taxes on any interest earned on the new investment property. Other benefits of deferring taxes include reducing your ordinary income tax rates as well as becoming eligible for accelerated depreciation and expensing allowances on your rental properties.
Finding a 1031 exchange partner
Finding a 1031 Exchange Partner is simple. You’ll need to find a tax professional that specializes in the 1031 Exchange and then establish your plan with them. If you’re planning to use Section 1031, the IRS requires that the property be appraised for fair market value before the sale of one property can impact another. This means that your tax professional will be able to provide you with an appraisal on your property and make sure it meets all of the requirements for this strategy.
You can also refer to JLM Real Estate as we also handle 1031 Exchanges in the San Diego Area.
The benefits of 1031 exchanges
There are a number of benefits that come with using Section 1031, including the ability to defer the capital gains taxes you would otherwise owe on the sale of your investment property.
Examples of these benefits include:
- The ability to reinvest in other investment properties without paying the tax on capital gains.
- A strategy that lets you profit from appreciation in real estate without having to sell your primary residence.
- Protection against market volatility by keeping your money invested in real estate as opposed to cash or stocks.
These benefits allow investors and landlords to get better returns on their investments while protecting themselves from market volatility.
How do I find a 1031 partner?
The 1031 Exchange is a tax and investment strategy, and it allows property owners to defer the capital gains taxes they would otherwise owe on the sale of their investment property.
The 1031 Exchange is also called a like-kind exchange because the new property must be of like kind to the property relinquished. This means that if you sell your rental property for cash as an investor, you can use Section 1031 to reinvest as a landlord by purchasing another rental property that meets these requirements. To understand how this strategy works, take a look at some of its benefits and how to use it.
One way to find a partner is through your network of friends, family, or co-workers. If someone you know has an extra piece of real estate they’re looking to sell in exchange for cash, consider offering them the opportunity to become partners with you in buying and selling properties together. You’ll both benefit from the increased cash flow and potential tax savings that come with this type of partnership.
The process of acquiring exchange property
The 1031 Exchange process is fairly simple. The steps you’ll take to exchange property vary according to your state and the type of property you’re exchanging. In general, though, the following are some of the steps a taxpayer must take in order to use Section 1031:
- Exchange properties that are considered like-kind such as real estate or securities
- Identify your property and determine a fair market value for it
- Contact your tax advisor about how to set up the exchange and make sure all the requirements are met
- Use Form 8824, “Statement for Exchanging Property,” to detail each step of the transaction
What are the tax implications of exchanging property?
Section 1031 allows investors to defer the tax they would otherwise owe on the sale of their investment property. It also gives them the opportunity to exchange property with a like-kind replacement, meaning you can sell your old home and use the proceeds to buy a new one. However, there are some restrictions when it comes to exchanging properties and not every property is eligible for this strategy.
To start, Section 1031 only applies to real estate that is used as a primary residence or investment property that has been held for at least two years (7 years for commercial property). You must also exchange properties of equal value in order to take advantage of this strategy. Finally, you cannot use Section 1031 if you’ve owned the property less than 60 days before selling or exchanging it.
Is your property eligible for the 1031 Exchange?
JLM Real Estate in San Diego can help you today and provide you with a free property valuation.
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