A 1031 Exchange is a common, fairly straightforward strategy that gives you significant tax advantages as a commercial property owner. Also known as a tax-deferred exchange, real estate investors may sell or relinquish certain qualified property, reinvest proceeds from that property and acquire a replacement property, pursuant to certain time limitations and other regulations. Simply stated, at time of sale, sales of real property are taxable in the year in which you sell the property, but employing a 1031 Exchange defers the taxable event.
So 1031 Exchanges sound great right? While they are great, much like everything in the world, they are not for everyone. To those ends, today we wanted to share a few benefits and drawbacks of engaging in a 1031 Exchange.
ADVANTAGES
1. A 1031 exchange involves a deferral of taxes
This is the obvious one. A 1031 Exchange allows you to sell your investment property and reinvest in a replacement property in order to defer ordinary income, depreciation recapture and/or capital gain taxes.
2. Exchanges allow you to leverage an increased cash flow for reinvestment
By deferring taxes, you will have more money currently available for investment. This increased purchasing power gives you the extra leverage to acquire, for example, a property or several properties with significantly higher investment benefits than if you sold the original property, paid all the taxes associated with the sale and purchased a new property.
3. Exchanges give you relief from management
If you own a property or several properties burdened with extensive maintenance costs and requiring intensive management, you may exchange and replace property for others with less responsibility (e.g., having an on-site manager).
DISADVANTAGES
1. There are multiple procedures, rules and regulations to follow.
The IRS has established regulations in a 1031 Exchange in accordance with the competing interests of collecting taxes and rewarding taxpayers for investing back into the economy. If these regulations are fully complied with, no income will be recognized at time of the commercial property exchange transaction. Not strictly adhering to these regulations, however, could doom your tax status and in fact you could incur certain penalties. (The work around on this of course is working with a firm like ours that can guide you through the process, effortlessly).
2. You may have difficulty in meeting the IRS rules and regulations.
Not surprisingly, investors frequently hit roadblocks when trying to comply with 1031 Exchange regulations. A common problem is finding a replacement property within the first 45 days after the sale of your relinquished property. To make matters worse, the IRS generally does not allow extensions of this time. That is why it is so important to meet with a real estate advisory, many of which specialize in identifying and structuring 1031 exchange opportunities, to assure your 1031 is a success.
3. The taxes are only tax deferred, not tax-free.
Remember, this is a tax-deferred transaction, not tax-free. When you decide to sell, your tax liability will be fully recognized.
NO MATTER WHAT
Executing a 1031 Exchange should be completed under the guidance of a seasoned professional. You can get tripped up on the many complex rules and regulations that the IRS sets forth.
Our firm is well established, expertly knowledgeable and can provide critical assistance in assisting you in assessing your tax liabilities of a sale versus an exchange, whether an exchange suits your investment goals and overall plan and finding a suitable replacement property.
