How to conduct a 1031 exchange
As a player in the real estate game, you must be aware that each and every dollar that you have invested is compounding your wealth, and, in contrast, that each and every dollar that isn’t working for you can be considered a missed chance to increase your profits. So, when the time comes to make a sale on a piece of property, you have 2 options. The first way in which you can cash in on your property’s appreciated value is to sell the property up front and recognize a capital gain. This means you’ll have to pay capital gains taxes on the proceeds. But every time you had money over to the United States government in the form of taxes, you are losing potential profits.
The second and more profitable choice is to conduct a 1031 exchange. An exchange is a great way to keep more of your investment funds working for you. A 1031 exchange has a provision of non-recognition, meaning you do not have to pay the taxes immediately following your sale; in fact, your taxes are deferred for an indefinite time span, while your money is compounded by the extra income produced by investing your tax deferment.
By way of example, imagine you are the owner of several small investment properties, such as duplexes, whose values have appreciated during the time you have owned them. At this point, your first instinct may be to make an outright sale and reap the benefits of your investments. A wise investor with an eye to the future might choose to make an exchange and put the money gained from the sale of these investment properties towards buying another, larger investment property, which will, itself go on to increase in value over time and continue to compound your wealth. Best of all, the extra funds at your disposal from your tax deferral will function to heighten your capacity to leverage for greater loans, maximizing your future profits.
Section 1031 doesn’t apply just to land and buildings, either. It is possible to make a 1031 exchange on any real estate held for investment in a business or trade, in addition to certain types of personal property, from cranes or backhoes to airplanes or classic cars. In fact, a 1031 tax exchange is particularly beneficial to those who have invested their funds in collectibles or antiques such as classic cars, because of the higher capital gains tax liability on the sale of these types of items. It is important to note, however, that you cannot exchange shares of stock, bonds, or interest in an REIT.
Next time you are planning to sell a piece of real estate or other type of property, take a moment to consider the potential dividends you could gain if you were to conduct an exchange. If you choose to make a 1031 exchange rather than selling your property up front, you can maximize your wealth and come out ahead .
