Suppose you’re trying to find the best way to maximize profits and reap the most benefits during a real estate exchange. In that case, it might be time to consider the many benefits of a 1031 exchange to real estate investors.
How could this exchange help you with tax deferral and other benefits during property swaps? Continue reading to explore how the 1031 Exchange works, how to leverage it, and the numerous benefits it promises to savvy real estate investors.
What is the 1031 Exchange?
At its core, the 1031 exchange is a tax benefit the IRS provides. Specifically, the 1031 Exchange comes from Section 1301 of the IRS Codes.
Investors use this code when exchanging properties, which defers capital gains taxes on a new property. Simply put, these gains will go directly into funding the new property rather than paid over to the tax authorities.
While you may eventually pay taxes on the investment property when you decide to sell it, you can avoid tax across the span of as many properties as possible by swapping. And, if you decide to sell and stop exchanging, you’ll only pay the capital gains tax once. It should leave you more cash than you started, but that’s not the only benefit.
How Does the 1031 Exchange Work?
Typically, the federal government taxes capital gains (when someone sells something for more than the original cost). A capital gains tax would apply to residential homes and investment properties, with the percentage varying from year to year and property to property.
However, with a 1301 Exchange, you can defer these capital gains taxes when making an investment swap. To qualify for the 1031 exchange tax deferral, you must make a “like-kind exchange.” So, you must use the proceeds from the exchange by reinvesting them in another property.
For example, a real estate investor may have purchased an investment building three years ago for $500,000. This year, they may have noticed the property’s value exponentially increase. If they were to sell it, they would incur tax on a large capital gain, thanks to this appreciation in value.
With high capital gains, the investor might decide to invest in another property instead. If they choose a 1031 exchange, the tax authorities will allow them to use the entire sum of capital gains for the next property instead of paying taxes on it.
The idea is to use this tax deferral to gradually trade up in the real estate market. It encourages investors to exchange for properties that are continually worth more and more in a bid to maintain some momentum in a fluctuating real estate market.
General Rules with the 1031 Exchange
However, the benefits of a 1031 exchange to real investors only become accessible through a set of rules and guidelines that you need to follow to qualify.
For instance, it must be a like-kind property exchange, which doesn’t necessarily mean one residential property for another. Any investment property may be eligible if the new property serves the same purpose (like selling an investment building for another).
Another rule with this provision is that the net proceeds post-sale must remain in escrow. As the seller, you cannot access these funds for other purposes. A qualified mortgage company like A and N Mortgage Services could come in handy if they’re willing to hold onto the capital gains for you before dispersing the funds into the new property.
Other rules surround the depreciation recapture, which is when you opt to swap different properties for one another, like raw land for an investment property. A professional mortgage broker on your side makes it far easier to discuss the details and avoid triggering this recapture for tax purposes.
The Many Benefits of a 1031 Exchange to Real Estate Investors and Others
Using a 1031 exchange is an excellent way to defer taxes, helping real estate investors gradually accumulate wealth through trading up to bigger investments. Here are a few details on the benefits that a 1031 exchange could bring to real estate investors if they approach it the right way:
Improve Portfolio Diversification
When you do not have the restraints of losing gains on every property you flip, new opportunities follow. Since the 1301 provision allows people to invest in properties out of state and swap different kinds of properties, it’s a wise strategy for getting a foot in the door. Plus, with one initial investment, you can spread the tax deferment money across multiple investments for a diversified real estate profile over the years.
Delay Capital Gains Tax
Utilizing the 1301 exchange for tax benefits is a great advantage. Instead of paying this capital gain post-sale, exchanging it for another property allows you to reinvest all the gains into another investment. It keeps your money under your control rather than paying a chunk of those gains to the government.
Swap For a Higher-Value Investment Property
The most noteworthy benefit of 1031 exchanges is more money to funnel into a higher-value investment property. When the tax deferment from these properties snowballs, you can continually invest until you’re ready to take advantage of maximum returns when you finally decide to sell.
Additional Read: How Mortgage Lenders Can Be Better Partners to Real Estate Agents
Frequently Asked Questions About the 1031 Exchange
What does “tax-deferred” mean when it comes to real estate exchange?
Tax-deferred for an exchange means that the authorities put off or delay the usual tax owed on capital gains so that you can put that money into another property. One of the tax-related benefits of a 1031 exchange to real investors could be the opportunity for capital gains to go into an escrow account for 45 days. It makes things simple until the next property settlement.
Does there need to be an intermediary third party?
Yes, a qualified third party should conduct the investment exchange, including holding your funds in escrow, providing agreements amongst parties, supplying deeds, transferring money, and more. Most often, the third-party qualified intermediary is a broker attorney.
Use Reliable Mortgage Services for the Best Use of the 1031 Exchange and Other Programs
With the 1301 exchange provision, licensed mortgage professionals navigate the process better than anyone else. Investors should stay in good standing with the IRS to avoid potential fines and depreciation issues. Why not rely on a seasoned mortgage team to help direct your finances for each property exchange you have in mind?
Do you want seamless real estate property transactions? When you’re ready, a team like A and N Mortgage Services comes in handy. We understand all the rules and regulations associated with the 1031 exchange and can offer you peace of mind about the upcoming real estate exchange.
You can learn more about these investments and mortgage services from our licensed and experienced mortgage lenders. We’re Better Business Bureau certified, fully trained, and highly experienced. Let us give you the best real estate buying, selling, or exchanging experience from start to finish!
Contact A and N Mortgage Services at (773)-305-LOAN to speak with one of the top mortgage companies. We will help you kick off your investment property exchange today!
