Posted in Blog  
  on Oct 27, 2014

1031 Exchange Rental Property

When you are working with rental properties, sometimes an exchange makes more sense than an outright sale. In a 103 exchange, which is often referred to as a “like-kind” exchange, one business asset is simply swapped for another asset. This trade is usually taxable, but a 1031 exchange has limited taxes that are due at most. Sometimes there are no taxes due whatsoever.

What you're doing is trading out one investment for another without a capital gain that is recognized by the taxing authority. This lets you keep your rental property investment growing in a way that is tax deferred. There are no limits on the amount of 1031 exchanges that a business can perform either. You can get rolling over gains from one piece of real estate to another and keep doing so for as long as you wish.



Why Is the 1031 Exchange Such a Good Benefit?


Let's say that you've purchased a distressed property for $50k. You've been able to repair it for $10k and now you're renting it out at $1,000 per month. In 4 years, the value of the property has increased to $85k. You can now use the 1031 exchange to sell this formerly distressed property for an upgraded property that you've rolled over the sales price to obtain.

The one issue that trips many rental property owners up, however, is depreciation. Any time you take depreciation on a property, you'll need to recapture the amount that you've taken. On that $50k property, for example, under standard depreciation, the investor will have taken 4/27.5 of the total value of the home, or about $7,300. In the 1031 exchange, even with the rollover taking place, there would be taxation on this $7,300.

Now here's some even better news. Although real estate and rental properties are generally the most common 1031 exchange that takes place, some personal property can also qualify. Anything that has a depreciating value can qualify.



A 1031 Exchange Can Be Delayed As Well


Most of the time, a 1031 exchange happens when one rental property is traded for another. The chances of finding an exact property swap are remote, however, so Starker exchanges are the most common transaction. This is a three party swap where one person holds the cash after you sell a property and then uses that cash to purchase the replacement party. Although it is a buy/sell transaction, it is seen as a swap and qualifies as a 1031 exchange.

To qualify for the exchange, however, the full transaction must be completed within 45 days of the sale of your initial property. If you do not designate a replacement party in writing to the third party, then you will be subject to capital gains taxation on the sale of your rental property. You also can't ever receive the cash from the property sale or you'll lose the benefit.

As long as you close within 6 months of your sale, a 1031 exchange can help you avoid a number of taxes that would regularly occur otherwise. Use this tax law to upgrade your rental properties and you'll soon be able to build your own real estate empire up over time.

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