The term "1031 exchange" refers to Section 1031 of the Internal Revenue Code. It's not a tax loophole, despite what some people think. Instead, it's a completely legal option that allows you to sell your investment property and avoid capital gains taxes if you reinvest the proceeds in a "like-kind" property or properties within a set amount of time.
The primary benefit of a 1031 exchange over simply selling one property and purchasing another is the tax deferral. A 1031 exchange allows you to postpone capital gains taxes, allowing you to put more money into the replacement property.
There is also no limit to the number of 1031 exchanges you may do. As long as you keep possession of your assets for at least two years, you can continue to sell and exchange properties as often as you like. Your initial investment will rise over time, and each swap will profit from it until the day you decide to sell for cash.
Other Benefits of 1031 Exchanges Include:
- Carry Over of Depreciation. If you sell a property outside of a 1031 Exchange, you'll have to pay taxes on the depreciation you took over the years you owned it, which is generally around 25%. However, when you use a 1031 exchange, you can carry the depreciation over to the replacement property where it is deferred again to a later time.
- Greater Purchasing Power: Deferring capital gains allows an investor the purchasing power to acquire more assets, while increasing his or her next worth.
- The ability to acquire higher-yield assets: Taking a profit on the replacement property while deferring capital gains can open the door to acquiring higher-yield investment properties with more units or income potential.
It's important to keep in mind that 1031 Exchanges can be complex and you'll want to build a relationship with a qualified intermediary before you put your replacement home on the market. If you attempt to take advantage of a 1031 exchange after the house is sold, it will be too late.
The good news is that our team here at Brazos 1031 Exchange can help you with every aspect of this process. If you have additional questions or you would like to know your options, please contact us to schedule a consultation.