What Does a 1031 Exchange Mean and How is it Beneficial for Landlords?

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If you’re a landlord and looking to invest in more properties, a 1031 Exchange can be beneficial to you.

A 1031 Exchange allows you to swap one property for another while deferring capital gains taxes from the sale of the property you are selling. The IRS considers this a no-tax-loss sale, so you don’t owe any capital gains tax on the amount you sell your current property for. Yes, when done correctly, a 1031 Exchange allows you to defer 100 percent of the capital gains taxes on the sale of real estate. Reuse the money that you would’ve paid toward capital gains tax and use it as funds for your next property. Best part is you can do this repeatedly and 1031 Exchanges are available to both individuals and commercial entities.

A 1031 Exchange is one of the most powerful tools in real estate investing. Set yourself ahead of the curve by learning how you can benefit from this exchange!

What Does a 1031 Exchange Mean?

A 1031 Exchange is a tax deferral for some real estate investors, as the name implies. It’s a way to defer some of the tax burden if it’s put into another real estate property. It’s a common misconception that a section 1031 Exchange is a specific type of deferred exchange. 

As we know, this 1301 Exchange allows real estate investors to defer capital gains on the sale of their property by reinvesting the proceeds of the sale in another property but one of the catches with this is that it has to be done while adhering to several specific rules. 

To qualify for the 1031 Exchange, the property must be “like-kind”. Generally, this means that the replacement investment property will be another investment property. Examples of investment properties are multi-family dwellings, office buildings, retail properties, industrial buildings, warehouses, apartments, storage units, single-family homes, mobile homes or vacant land.

The key here is that the exchange is only allowed if the proceeds are used for purchasing another property that’s similar. You can use this opportunity to purchase different properties, such as a vacation home or a rental property. 

For example, you purchased a single-family home for $200,000 and sold it for $225,000. If you purchased a $250,000 apartment building, you would use that $25,000 to purchase a different apartment building and then use the $200,000 for other purposes. The tax savings allow you to stretch your dollar further.

To qualify, the taxpayer must hold the prior property, the new property, or both, for at least one year or use them as rental properties. There are other conditions that go along with this. If you don’t know what you’re doing, you may end up paying more in taxes, not less! If you’re too greedy, you may end up losing all the money you made on the sale.

Like-kind exchanges are essential sources of retirement security specifically for those who don’t have traditional retirement accounts. For many Americans, real property is their main source of retirement income. This often includes self-employed or small business owners who do not have employer-provided pension plans. The 1301 Exchange allows the conversion of an active business into a long-term passive income stream.

Over the years, the regulations have changed several times, including as recently as 2017. Exchanges are now only allowed for real property. Real property includes real estate that supports important social and environmental objectives including land conservation and the preservation of family-owned farms. 

Note: The title on the replacement property must have the same name(s) as that property on the relinquished property. If you buy into a property with additional people, each and every one of them has to be involved in purchasing the replacement property otherwise it will not qualify.

How is a 1031 Exchange Beneficial for Landlords?

1031 Exchanges represent a large portion of real estate transactions. For landlords, a 1031 Exchange can help you in a lot of ways. Not only is this a huge benefit to landlords, but it can also be a benefit to buyers. 

Firstly, a 1031 Exchange can help in allowing you to switch your current properties in order to make a profit. If you have a property in a region where the market has gone down, you can switch it with a property in a region where the market is up. This will help you in avoiding a loss in the value of your property for a while. In order to take advantage of a 1031 Exchange, you must be sure that you meet the qualifications.

Investors who engage in a 1031 Exchange must follow strict guidelines for the exchange to be valid. Any cash received or paid out in connection with the exchange must be reported on the investor’s tax return.

If you’re looking to avoid paying capital gains tax, the 1031 Exchange is the most common financial technique. When utilizing a 1031 Exchange, it can be a beneficial key to building wealth especially if you keep your property investments through the duration of your life. When you pass away and you are holding investment property that had been part of a 1031 Exchange the tax owed goes away, it is not passed on to your beneficiaries. All of the built in gain disappears upon the taxpayer’s death. The value of the property at the date of your death would pass through your estate to your heirs.

Why Are Rental Properties the Ideal Candidate for a 1031 Exchange?

This is a great way to earn passive income as a landlord. If you own an investment property, a multi-family apartment building or commercial real estate complex, you more than likely qualify for 1031. Provided the property is held for business or investment purposes, rental properties are the ideal candidate for a 1031 Exchange due to the definition of what qualifies as an acceptable relinquished property.

The better landlords and property owners understand how the 1031 Exchange works, the more likely it will be to support its continued viability. 1031 Exchanges are important elements of the real-estate ecosystem that have benefits well beyond tax deferrals. If a property qualifies, it is one of the best tax benefits and ways landlords can profit that is available. Build your wealth until you need to access it, if ever.

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