There are numerous ways to fund your next real estate investment. One method that is used by investors to help them defer taxes on real estate is a 1031 exchange. Essentially, you are taking the equity of one property and exchanging into a new property or properties.
While you should consult your tax professional regarding the specifics of your investing situation, knowing how a 1031 exchange works can help you make the right investment decision.
One of the most important aspects to properly conducting a 1031 exchange is centered on time. After you’ve sold a property you have approximately 45 days to identify replacement properties. Next, you have 180 days after the close of escrow to complete the acquisition of the replacement real estate asset. Attorney David Greenberger, Esq. from my1031place recommends to make a 1031 exchange successful you should be looking for a new investment before your property sells. “Since you only have 45 days to find something and 180 days to close on it, time is essential,” David further explains.
Types of Real Estate
The IRS stipulates that the replacement properties must be “like kind;” this means you can sell any real estate asset and exchange it for any other real estate asset. The investment you make on the new properties need to be equal or greater to take advantage of the full tax deferral.
3 Properties Rules
While each 1031 exchange is unique, the IRS does have several rules regarding how it works. You can purchase a maximum of three replacement properties without regard to fair market value or follow what is referred to as the 200% rule. If you purchase more than three properties, the total aggregate value of all replacement properties cannot exceed 200% of the relinquished property value.
Here’s an example of the 200% rule:
There are three primary benefits that come with using a 1031 exchange:
- Tax: As mentioned previously, most investors look toward the 1031 exchange for a means to defer taxes paid on real estate.
- Leverage: If the property you had originally purchased is paid for free and clear, you could use the capital to reinvest with leverage on a larger real estate opportunity.
- Diversification: Instead of putting all your eggs in one basket you can take the proceeds from your real estate sale and invest it into several residential real estate opportunities. By investing in different cities, you can add an extra layer of diversification to your portfolio as each market has its own local economic conditions.
Is a 1031 Exchange Right for You?
If you are planning to sell your real estate asset soon, a 1031 exchange could be the right move for you. Using this strategy means you could defer taxes, provide diversification to your portfolio, and continue to build wealth with real estate.
If you’d like to learn more about how you can create a 1031 exchange strategy, schedule a consultation with us.