A good real estate agent studies more than just the local real estate market. At 5 Points Realty, we keep our eyes on economic trends, mortgage regulations, and any tax changes that might impact our buyers and sellers.
Recently, we were reading up on 1031 exchanges… 1031 exchanges refer to Section 1031 of the U.S. Internal Revenue Service’s tax code. This provision “allows you to postpone paying tax on the gain if you reinvest the proceeds in similar property as part of a qualifying like-kind exchange. Gain deferred in a like-kind exchange under IRC Section 1031 is tax-deferred, but it is not tax-free.”
Basically, it’s a way for smart real estate investors to defer paying capital gains tax on the sale of an investment property by rolling it onto the new property. So, instead of paying the tax at the time of the first sale, you pay the tax at the time of the sale of the second property.
Now, we are talking about an IRS regulation here so that means there is a lot of fine print to review before you decide if it works for you. The exchange only works with like-kind properties and the use of the provision for vacation properties is limited. It is intended for investment and business property, though there are a few exceptions. There are also time frames to consider that may prevent its use.
However, when applied effectively, 1031 exchanges increase your purchasing power. Investors can leverage the proceeds of an investment property sale to build bigger real estate portfolios. Here’s how it works. If you sell a building for $500,000 you would normally pay around 150,000 in taxes, leaving you with $350,000 to buy a new property. With a 1031 exchange you don’t pay the taxes right away, meaning you have a full $500,000 to invest in a NEW like property.
With some sectors of commercial real estate predicted to see robust growth in 2021 and interest rates expected to stay low, the stage is set for a strong year of 1031 Tax Deferred Exchange activity.
We pulled some of the most interesting findings from Investment Property Exchange Services. Here are a few trends they are anticipating that we think could help Charlotte area investors.
- Continued 1031 growth in industrial, self-storage, R&D, medical/office, and multi-family sectors.
- Individual exchangers will continue to sell investment property and purchase Replacement Property in warmer climates or other locations with high vacation rental income.
- Continued increase of Replacement Property purchases of qualifying vacation home rental properties.
1031 exchanges can also be helpful in estate planning… helping to keep your equity working for you. Talk to your financial planner or service provider for more information on how this can be used in your retirement planning.
It is a complex provision but one that could be worth it, depending on your situation. You will definitely want to consult professional help in this area to make sure you don’t make any mis-steps.
And in the meantime, we will keep looking for things that might give you an edge in your real estate investment goals.