The Advantage of 1031 Exchange

by Josh Biggs in Finance on 20th August 2020

Real estate investments provide investors many opportunities for income generation, portfolio diversification, and asset protection. Some of these are through capital appreciation resulting in capital gains, rental income, project investment and lending, and also present-purchasing for future use. However, these benefits hold different tax implications. 

As investors, our main goal is to maximize our wealth and profit. This leads us to seek different strategies to minimize or defer taxes as much as possible and simply protect our investments. For real estate investors, 1031 exchange is an ideal tool for tax deferral, and here’s why:

1031 exchange is one measure to defer capital gain taxes. 

When one sells a property that has already appreciated, this means a higher price becomes reasonable as demand for land and building increases through time and brings you proceeds. These proceeds incur capital gain taxes. With 1031, it allows proceeds to be further invested in a different like-kind property or project for the payment of taxes to be postponed. When we say like-kind, the nature of the property must be similar to the properties you are exiting holdings. This is why it is called an exchange. You are simply exchanging the property for a new fitting replacement and creating the case of earning the gain later on as it had been immediately spent on a new investment. The gain will accumulate from the previous property to the other and so with the tax that these gains bear. Your initial income thus enters a cycle of a continued income generation making your future earnings larger than the value you expected to earn from just selling the property. 

1031 exchange contributes to portfolio longevity

As the cycle continues from one property to the next, every property becomes of larger value with the gains, so the like-kind property to be invested upon must be of almost similar value to this new amount. Thus, the amount of investments grows, and because it becomes higher, it can add up to the longevity of your portfolio and earn further potential benefits.

1031 exchange gives you the opportunity for change

Although the only property you can exchange your previous investment for is like-kind, there is still a possibility for a change in the property type whether it be from residential to commercial, or land to residential, and others. 1031 exchange also gives you a chance to change your location or target markets with your new property. More so, you can also purchase a property where your management obligations would be different from before. Maybe you would like a new property that would be easier to manage, or you would want to enter a Delaware statutory trust where the intermediary handles all management tasks.

1031 exchange brings you greater income opportunities

With being given the ability to change from land to commercial or residential property through 1031, you are also presented with different income generation potentials. You may buy residential properties where you can earn rental income for future tenants. You may also buy commercial properties from promising areas, and start or expand your business.

Categories: Finance