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Trading Up Using the 1031 Exchange

In spite of decreasing real estate values across the nation, real estate investors continue to come up with innovative ways to make their investment turn out profitably.

 

A powerful method for building real estate holdings is the use of 1031 Exchanges, which lets investors defer capital-gains assessment on investment property by reinvesting sale proceeds into the purchase of new property within a set time period.  Though 1031 Exchanges have grown in popularity as the number of active real estate investors has grown, 1031 misperceptions continue.  Here are some basic 1031 Exchange questions.

What is a 1031 Exchange?

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A 1031 Exchange is a tax avoidance tool that allows you to defer capital gains tax to a later date when selling investment real estate, permitting you to reinvest money  from the sale of one property to another.  You are, essentially, ‘exchanging” one property for another investment property of equal or greater value.  When the replacement property is ultimately sold (not as part of another exchange), the original deferred gain, plus any additional gain realized since the purchase of the replacement property, is subject to tax.

Why do a 1031 Exchange?

 

There are three basic advantages to investors in making an exchange:
1. To grow your portfolio:  In deferring your tax burden, you are getting an interest-free loan on the tax dollars you might have owed on your property sale. Your immediate tax savings is, thereby, employed instead as investment capital in a replacement property.

2. To convert your “gain” into immediate equity and tax-free cash:  The 1031 Exchange provides more equity, which lets you to move up into properties of increasingly higher appraisal every time you perform a 1031.  Also, there’s an another benefit:  Once your old property is sold and the succeeding property is purchased, you can turn around and refinance the new property, taking cash out as a loan for anything you want, and the money tax-exempt as income.

3. To utilize as an estate planning tool:  Families that intend to pass along real estate holdings typically deed them into a family partnership or LLC (limited liability company).  Management income can continue to be drawn from the properties by the parent or principle, but heirs will inherit the property without taxation .and “can continue to 1031 Exchange the property and grow a real estate portfolio,” according to attorney David P. Greenberger.