Are you interested in entering into a 1031 exchange? A 1031 exchange, also known as a like-kind exchange, tax-deferred exchange, or a Starker is a simple and easy strategy that provides considerable tax advantages to commercial property landlords. Thanks to the IRC (Internal Revenue Code) 1031, an investor can sell or hand over particular qualified property, then reinvest the profits from that certain property and get a new replacement property, under particular time limitations and other regulations.
Here are the differences between a good and a bad 1031 exchange. Understand them so that you can navigate the process of a Starker exchange better.
The Good Aspects Of A 1031 Exchange
1. Deferral of Taxes
With a 1031 exchange, you are able to sell your property and then reinvest the proceeds in a new property to defer capital gain taxes, depreciation recapture, or ordinary income taxes. These types of taxes can be pretty considerable particularly with a low adjusted expense basis. That is why the IRS tax code allows you this invaluable exception in exchanging investment properties.
2. Leverage and Higher Cash Flow for Reinvestment
With deferring taxes, you’ll have more funds on hand for investment. With this increased buying power, you can acquire extra leverage. For instance, one or a couple of properties with notably greater investment profits than if you sold the primary property, paid all the taxes linked to the sale, and bought a new investment property.
3. Relief from Management
If you are a landlord of a single property or a few properties burdened with substantial maintenance expenses and needing intensive management, you can exchange and replace the property/s for other property with less responsibility (for instance, a property with an on-site manager).
4. Wealth and Asset Accumulation
A 1031 exchange is an excellent wealth building tool. If you are a commercial real estate investor who executes 1031 exchanges through your life, you already know that you benefit from notable net worth and cash flow increases. You benefit much more than a real estate investor who decides to sell and pay taxes every time a sale happens.
In essence, an investor could exchange into a lot of investment properties over the years and then pass those investment properties on to their heirs at the time of their passing. At that time, their heirs can realize a set-up on the expense basis of all of those property investments to the current fair market value, eliminating the tax burden altogether.
The Difficulties Of A 1031 Exchange
5. Procedures, Regulations, and Rules to Follow
The IRS tax code has established regulations in 1031 exchanges in accordance with the involved interests of gathering taxes and rewarding taxpayers for investing again in the economy. If you fully comply with these regulations, income will not be recognized at the time of the commercial real estate property exchange transaction. However, if you are not strictly adhering to these regulations, it could doom your tax status, and you could even incur some particular penalties.
6. Difficulty in meeting IRS Code Rules and Regulations
Not surprisingly, investors often come across obstacles when trying to comply with 1031 exchange regulations. Finding a new replacement investment property within the 45 days after you sold your relinquished property is a common problem. And to make this even worse, the IRS tax code typically does not allow extensions of this period.
That’s why it is so essential to consult with a real estate advisor. Westwood Net Lease Advisors specialize in identifying and structuring the 1031 exchange processes. We will make sure that your 1031 exchanges are successful.
7. Reduced Basis on a Property Acquired
Due to the 1031 exchange, there’s a reduction on the new replacement property’s tax basis. The tax basis of the new replacement property is the buying price less the deferred gain on the sale of your relinquished property as a result of the 1031 transaction. Thereby, you decide to sell the replacement property, then the deferred gain will be taxed.
8. Losses Can Not be Recognized
Losses are deferred, same as the applicable taxes. For instance, in a windfall profit year, deferring losses that might have offset substantial proceeds could be a dangerous decision. You must very carefully weigh the benefits of that kind of a deferral. Contact our professional Westwood Net Lease Advisors for a more worry-free investment.
9. Future Increases in Tax Rates
If you plan on selling your new investment property in the future, then you may see more significant capital gains tax rates and other tax hikes.
10. Just Tax-Deferred, Not Tax-Free
Bear the following in mind; it is a tax-deferred transaction, not tax-free. So if you decide to sell, your tax liability will be recognized entirely.
It is wise that you execute a 1031 exchange under the expert guidance of knowledgeable professionals such as our Westwood Net Lease Advisors. If you do not look for a professional help, you might easily get tripped up on the many complicated rules and regulations that the IRS tax code sets forth. Finding a seasoned professional is crucial in assisting you in estimating your tax liabilities on a sale as opposed to an exchange, whether the exchange suits your investment goals, and the overall plan and finding the right replacement property (if that is the route you choose).
If you have any questions regarding your entrance into 1031 exchange, feel free to contact Westwood Net Lease Advisors or send an email to firstname.lastname@example.org.
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