Compounding and leverage are two simple ways to make capital gains in real estate. In the case of the former, the investment grows exponentially over time due to the application of compound interest. With regard to the latter, a certain amount of money is borrowed and invested in such a way that the rate of return is greater than the rate of interest charged on the loan. The 1031 exchange, also called a tax-free exchange or a deferred exchange, gives you the opportunity to leverage and capitalize and therefore make capital gains quickly and easily.
What is the 1031 exchange?
The 1031 exchange is the US Internal Revenue Service Code that specifies that if an asset such as land, residential property, or a commercial building is sold and the money obtained from the sale is used to purchase one type of asset something similar, then neither gain nor loss is recognised. Due to this, the applicable taxes on the profits obtained are deferred. An important aspect of 1031 is that it is a law and not a loophole that takes advantage of the intricate technicalities of the law. Therefore, it is a perfectly safe and legitimate way to make capital gains in a short period of time.
What are the rules that govern the 1031 exchange?
The most important rule is that the real estate involved in the transaction must be of the same type. According to the following rule, the sale proceeds are handled by a Qualified Intermediary (QI). It is an independent facilitator who receives and holds the funds until they are used to purchase a new property of the same type. The third rule of the 1031 exchange states that the value of the replacement property must be greater than or equal to the property that was sold. If the value of the replacement property is less, then you would have to pay taxes on the decrease in price.
In addition to the rules above, you should also be aware of two timelines associated with the trade. The first is a 45-day identification period during which you must identify and propose the replacement properties you wish to purchase. The second is a 180-day exchange period during which you must complete all paperwork related to purchasing the replacement property.
What are the main benefits of the 1031 exchange?
The sale of real estate can attract income tax obligations of up to 35%. Not only can these taxes significantly reduce your capital gains, but they can also decrease your ability to purchase larger, more profitable properties. The 1031 exchange allows you to reinvest all of your capital gains in one or more properties of the same type. It is a remarkable wealth building tool that helps you vastly increase your cash flow and net worth. One thing to remember about IRS Code 1031 is that it is simply a method of deferring taxes. At the time you decide to sell your properties, you would have to pay the taxes.
Some more benefits of 1031 are as follows:
• It allows you to buy properties in different markets of different states.
• You can consolidate countless smaller properties into one larger property, thereby reducing property liabilities and increasing property profits.
• You can also change the location of your investment. Instead of owning property in a less desirable location, you can purchase real estate in a more profitable location.
• Finally, you can also reduce your management obligations. From high maintenance properties, you can switch to properties that require little management.
All in all, the 1031 exchange is a good way to easily make capital gains throughout your life. All you need to do is comply with the rules and explore the benefits.