One of the most powerful tools in the real estate investors arsenal is the 1031 exchange. In our current market cycle with a great disparity among markets throughout the country, now may be an great time to take advantage of this opportunity to expand and diversify your real estate portfolio. It could be a time to sell high and buy low.
Okay, you made the jump from the front page to the full page. Thanks. But before going further, let me state clearly, I am not a tax professional or a financial adviser. Please check with one or both of those practitioners before proceeding to verify the information below and to determine if this is right for you.
Anything involving the IRS has many rules and regs. In the near future, I will be posting a detailed outline of the 1031 process under the investor tab but for now, here are the basics.
WHY DO A 1031 EXCHANGE?
When one sells a real estate investment, one pays taxes on the gain (currently 15%) and also on the recaptured depreciation at the individual’s normal tax rate. By executing the exchange properly, one can defer the tax liability until the new, replacement property, is sold in some future year.
Within 45 Days of of settlement of your current property (the relinquished property) you must “identify” the new property or properties (replacement property). Then you must settle on the replacement property or properties within 180 days of settlement of the relinquished property. There is no flexibility on the timeline – miss the deadline and taxes are due.
WHAT CAN YOU BUY?
You can trade your existing real estate for any other type of real estate. You are not limited to trading a residential rental for a residential rental. You can trade a residential rental for an office building or a piece of land. Also, and this is very important, you can trade, based on the values involved, (more on that in another post) 1 piece of real estate for 2 or3 new pieces of real estate – a great way to expand your portfolio!! You can not trade real estate for other investments like stocks or art. The replacement property must be in the US.
SO WHY IS NOW A GOOD TIME TO DO THIS?
The Northern Virginia real estate market has appreciated about 3.5% in the last year, inventory is down and average marketing time for a properly priced and presented home is often less than a month. Yet, around the country, several markets are still depressed but the rents in those markets are strong and the properties offer excellent cash flow. I have spoken with out of town investors thinking of selling their property here and buying in their hometown where the values are too hard to resist. Plus, as I always say, real estate is not stock. Real estate investments are long term purchases. These folks believe their markets will recover and they will get great cash flow while they wait.
Other folks who live in Northern Virginia can take advantage of market irregularities by selling here and buying in another market they may be familiar with and one that offers great cash flow. One of my great investor clients demonstrated this to me a few years back. In the early 90s, I helped him buy a single family investment property in the Greenbriar subdivision in Fairfax. In the mid 2000s, he had substantial equity in the property. He sold it using a 1031 exchange and bought a duplex in Raleigh NC, a single family in Dallas TX and a condo in FL. What a way to expand and diversify!
And last, there are people sitting on tremendous equity in their Northern Virginia property. If that equity could be accessed it would be possible to trade 1 Northern Virginia property for 2 other Northern Virginia properties. Even though prices have increased, with today’s low interest rates, there are still may places in our community where one can get positive cash flow. A 1031 will unlock that equity.
Just a few thoughts on how to use a 1031. Have you ever executed an exchange? How did it go?
Photo credit: renjith krishnan