A 1031 exchange (also known as a like-kind exchange) is a tax-deferral strategy that allows investors to defer paying capital gains taxes on an investment property when it is sold, as long as another similar property (which is defined as “an incoming property”) is purchased with the profits from the sale. It’s mainly used in real estate investing. Here are some of the current benefits.
Pros:
- Tax Deferral:
- The biggest benefit is the deferral of capital gains taxes. By rolling the profits from the sale of one property into the purchase of another, investors don’t have to pay taxes immediately on the capital gains.
- Increased Buying Power:
- Since you’re deferring taxes, you may have more capital to reinvest into the new property, which could mean you can purchase a higher-value property or a property with better long-term appreciation potential.
- Portfolio Diversification:
- You can diversify your real estate holdings. For example, if you sell a medical-office property, you could reinvest in residential rental, multi-family real estate, shopping centers, industrial properties such as an Amazon Distribution Center or FedEx distribution center or a different medical location to spread risk. Having your real estate and your operations in the same facility is not diversifying risk. Selling ASC real estate and purchasing a different property type is a great way to diversify.
- Leverage Investment Growth:
- The ability to defer taxes means more of your money stays working for you, which can lead to greater compound growth over time.
- Estate Planning Advantage:
- When the property is passed down to heirs, they receive a “step-up” in basis, meaning the capital gains tax is effectively wiped out. This can be a powerful estate planning tool. Please discuss any time estate planning with qualified attorneys and accountants.
- Preserves Cash Flow:
- Instead of paying taxes on a sale, you preserve more cash to continue investing in more properties, which can help build long-term wealth.
The tax code and interpretations can change and it always recommended to discuss a 1031 exchange with your CPA and tax professional to make sure it meets your requirements.
