If you are the owner of a business or you own an investment property, you may have heard of the 1031 IRS code that enables you to invest all of the proceeds from the sale of an existing property that you hold onto a new one, while also deferring all capital gains tax. Many people know that a 1031 exchange can be a valuable business maneuver, but they aren’t sure exactly how or why.
So, how exactly can a 1031 exchange benefit you? There are a number of distinct advantages to utilizing this tax deferral option. These include the following:
Leverage For Future Investments
When you choose a 1031 exchange, you can use the money that you would have otherwise paid to the IRS in taxes to put towards your like-kind property. By offering a significantly larger down-payment, you will improve your buying power, making it easier to acquire a more expensive and valuable investment. Since capital gains are taxed at a maximum rate of 20%, if you have a property worth $200k, you could potentially save $40k to put towards your next investment – which could be enough to get you a significantly better deal than you anticipated. As the value of your investment properties increases, you can repeatedly trade up for increased value while still deferring capital gains tax.
The Possibility of Diversifying Your Investment Portfolio
A ‘like-kind’ exchange doesn’t mean that you have to swap your current investment property for exactly the same type or even just one property. Like-kind properties are of the same nature, character or class. However, the rules are surprisingly liberal. This means that you can potentially exchange an apartment building for raw land, a ranch for a strip mall or a residential rental home for vacant land. You can even exchange two duplexes for a retail strip center. You aren’t limited to your current state either. There is nothing to stop you from making an acquisition in any state within the United States.
Generate Cash Flow
If your current investment property doesn’t generate any cash flow, you could carry out an exchange that enables you to acquire a commercial building that does or a rental property which will give you a monthly return. This could give you a valuable revenue stream, significantly boosting your business.
Ditch the Burden of Intensive Management
One of the biggest challenges of owning a rental property is the burden of managing the paperwork and dealing with any maintenance issues that arise. You can eliminate the time and expense of these issues by exchanging a high-maintenance rental for an apartment building where they are taken care of on your behalf.
Play the Long Game
The great thing about 1031 exchanges is that if they are done right, you can potentially defer the capital gains tax you would otherwise owe indefinitely, enabling you to build your investments and grow your wealth without limitations.