If you’re like most property owners, you either don’t know about 1031 exchanges or have the wrong ideas about them. Imagine you thought you had the right idea about them and you did not. This a real problem with many investors and their teams.
It gets worse. If you don’t know enough or have the wrong ideas about a 1031 exchange, you are probably missing the Hidden Opportunities in plain sight.
The simple fact is this: if you don’t do them often, you probably should consult a professional who does. Even better, hire an Intermediary that provides education to you and your investment team.
In this post, we’ll take a look at:
- The Concept
- How do you Qualify
- How do you find the Hidden Opportunities
- How do you take advantage of it
- Next steps
1. What is the concept?
Here’s a simple way of thinking about the 1031 exchange. It’s like playing Monopoly® for real. It’s not about getting out of your taxes!
Think about the goal of Monopoly®…to build wealth by adding more properties that produce more income.
For example, if you take your 4 “Green Houses” you own on “New York Avenue” and “exchange” them for the “Red Hotel” you will increase your income in the game from a low of $16 to a high of $1,000 every time someone lands on your property. Now imagine you do that with real property!!
In the real world, you would have to sell each of your 4 houses and pay taxes on the profit of each sale before you could combine the money to buy the larger property. This is known as Capital Gains taxes. There are also other taxes like Depreciation Recapture as well. The issue is that the taxes would reduce the amount of money you have to buy the larger property, thus reducing the amount of income you can make.
The 1031 Exchange is a section of the Internal Revenue Code (IRC). It allows you to indefinitely defer your taxes on the capital gains (or “profit”) of the real estate sale, by “exchanging” qualified properties for others of the same value and investment or business usage. In the Monopoly® analogy, the 4 houses combined are of equal value to the hotel and all are used for investment (collecting rent).
2. How do you Qualify?
You qualify to take advantage of this if you are a U.S. Taxpayer. Foreign Nationals may qualify if they take certain steps well in advance. They should contact their tax advisor for details. If needed, I can recommend several for you. This information is provided by The Private Exchange Group, Inc. as a general guide to understanding 1031 exchanges only. The Private Exchange Group, Inc. does not give legal or tax advice. You should contact your attorney, accountant or other financial advisor for legal and/or tax advice.
Any of your real estate properties qualify if you use them for business or investment. If you are “flipping” properties or using them personally beyond the requirements for investment you have to pay your taxes from the sale as they are not qualified for a 1031 Exchange.
3. How do you find the Hidden Opportunities?
It’s simple. Take a look at your portfolio. Ask yourself some of the following questions:
- Are your real estate holdings performing to your standards?
- Do you want to get more return out of them?
- Would you like to move them to different areas, types, sizes?
- Would you like to diversify or consolidate?
- Do you want to use leverage to increase the income of your assets?
- Do you own land and would like to exchange it for something that produces a monthly income?These are just some suggestions to get the conversation going. The 1031 Exchange can allow you to make changes to your real estate investment portfolio while helping to preserve the equity you’ve built up.
4. How do you take advantage of it?
After you analyze your portfolio, you may find the need to make some changes. If so, here are some steps to consider:
- Contact your real estate broker
- Contact an Intermediary.
- Have a Strategy meeting. You need to have a clear understanding of the 1031 rules and process relative to your goals.
- Decide what properties you would like to exchange into.
- Hire the Intermediary.
- Put your properties to be exchanged on the market
5. Next Steps
- Analyze your portfolio and look for hidden opportunities to increase and/or strengthen it.
- Educate yourself and your professional team on the 1031 exchange. Please don’t let yourself or others think that you know the concept and that is enough. In MOST cases it is not. If you are not actively doing this, I HIGHLY recommend you start from the beginning and let an Intermediary walk you through the rules and process relative to YOUR situation. The 15 minute call/meeting will be well worth the time. Please remember that this is simple until it’s not. A simple misunderstanding can cost lost equity opportunities, large tax bills, time and potential income or more.