1031 Tax Deferred Exchange – Is It Worth Considering 2016 Real Estate Trends
Tax deferred exchange, better known as a 1031 Exchange, can help commercial property owners significantly when it comes to taxes. It allows real estate investors to relinquish or sell specific properties (which qualify under the said rules), acquire another property from its proceeds and in the process defer capital gains involved in the transaction. To put it simply, you can defer the taxable gains if you use 1031 Exchange contrary to the traditional selling process.
Advantages of a 1031 Exchange
- Taxes are Deferred – Normal selling can invite taxes. However, a 1031 Exchange allows you to undertake investment property sale and subsequent reinvestment in another property while simultaneously deferring capital gain taxes, ordinary income and recapture depreciation. Traditionally, taxes can be significant in property selling. So, this IRS solution provides an invaluable exception to those looking to sell and reinvest again in a business property.
- Smooth Cash Flow – When looking for reinvestment, a 1031 gives you access to increased cash flow and leverage. Since taxes are now deferred, investors have more in their pocket to be used for investment purposes. Real estate investors can enjoy higher purchasing power giving them access to properties with considerably higher investment potential. Compared to selling the original property and exposing your gains to taxes, this option helps grow your commercial property portfolio.
- Streamline Property Management – Real estate investors with large commercial property portfolio have to spend significant amount of money on monthly maintenance, repairs and rental taxes. This burden can be reduced when you exchange and replace. Less responsibility means less management and higher profits potential.
- Wealth Building Tool – A 1031 Exchange is a long-term wealth-building tool if used in the right sense. Based on the principle of long term consolidation, it can be used to make a large portfolio through smooth cash flow, high leverage and lower taxes. Investors can look towards holding onto a high returns portfolio. Compare this to regular sell and buy process and investors know its obvious advantages. Theoretically, investments can be exchanged and growth achieved over the course of years. The increase in the market value of properties can also eliminate the taxes over long time.
Disadvantages of a 1031 Exchange
- Particular Rules, Procedures and Regulations – The IRS introduced this concept to make tax collection more refined and also reward people who invest back into the US property market. However, there is a well-defined set of rules to ensure that these benefits are availed by genuine applicants. Any lapses here can lead to penalties and even scar your tax profile.
- Time Based Regulations – The most common impediment in the way of 1031 Exchange is the time deadline. After selling the property, it is mandatory that the investor finds a replacement property for exchange in 45 days. No time extension is allowed.
- Selling Can Invite Taxes – If the investor decides to sell the exchange property, IRS applies taxes on the deferred gains. Tax liability is applicable since its not tax free – only tax deferred.
- No Loss Recognition – Losses are deferred in 1031 Exchange. So, in case an investor makes huge profits, the deferred losses can put a dent in the profits. The reduced margin is not to everyone’s taste.
- Dynamic Tax Rates – Taxes can go lower or higher as per the economic scenario. Tax hikes can eat into your profits if you want to sell the investment property somewhere down the lane.
A 1031 Exchange should be undertaken carefully with the help of a seasoned real estate professional. Keep your investment goals in mind. Novice attempt will only land you straight in the IRS net.
In 2016, property markets are still in flux in certain areas. With stable taxes, this can help genuine real estate investors in making the most out of this tight market. Also, approach this solution as a wealth and property building tool in order to gain maximum returns.
Revive Property Group