Section 1031 Can Help Accomplish 2019 Goals
As the year winds down, many of us are beginning our annual list of resolutions and evaluating our goals. For some, our goals might include the purchase of a vacation home, diversify our real estate portfolio, increase our revenue stream, retire and maybe even find more time to enjoy life. Yes, they all sound great but for those that currently own investment property, a 1031 exchange may help you accomplish these goals even sooner!
A 1031 exchange is a tax deferral strategy allowed under Section 1031 of the Internal Revenue Code. It provides that no gain or loss will be recognized on the exchange of real property held for use in a trade or business or for investment. The deferral includes the gain and depreciation recapture. A 1031 exchange is much like a sale followed by the acquisition of real property linked together by paperwork and completed within the required time periods. To maximize your tax deferral, you must acquire replacement property of equal or greater net value and net equity or pay tax on the difference. A qualified intermediary is an independent party that is required to facilitate your exchange.
Acquire a Vacation Home
Today's market conditions are providing incredible opportunities that may not be here when you are ready to buy a vacation home in a few years. While interest rates are starting to tick upwards, they are still near historic lows and make properties that were once out of reach now viable. While you cannot acquire a vacation home directly through a 1031 exchange, you can acquire a property that would be used as a rental for two years and then converted into your vacation home. Exchange an investment property for another rental in the resort area of your choice. Use the replacement property as a rental for at least two years while minimizing your personal use and then you can convert it to your vacation home.
Retire to a Warmer Climate
Similar to the strategy explained above, an investment property can be exchanged for a rental property that could be converted to your primary residence after two years. When selling the house you lived in before relocating, if you used it as your principal residence for at least 24 of 60 months prior to the sale, you can exclude up to $250,000 of gain if you are single / $500,000 if married filing jointly.
Business Exit Strategy
If you own a business and are planning to retire, you may also own real estate used by your business. While the goodwill associated with your business cannot be deferred through Section 1031, the real estate can be exchanged for other real property. This allows you to defer the gain and depreciation recapture but also buy something that will eventually be your retirement home or second residence and/or create a new cash flow.
Diversification of Properties
One of the great benefits of 1031 is the ability to diversify your properties to better fit your needs while creating a well-balanced real estate portfolio. Whether you wish to diversify the specific type of property or their geographic locations, 1031 can help you accomplish this goal.
Increased Cash Flow
Use 1031 to exchange your investment properties for replacement property with a greater return on investment. Whether the new property is newer, has more units or is closer to the water in a resort community, exchange up and enjoy your additional cash flow.
More Time to Enjoy Life
Anyone who has rental properties knows they can take quite a bit of your time to manage and maintain. If you have amassed significant real estate value, you might consider exchanging into a Triple Net Lease (NNN) property or Delaware Statutory Trust (DST) interest. A NNN requires the tenant to pay rent, as well as, some or all of the property expenses including real estate taxes, insurance, maintenance, repairs, utilities and other items. With this passive investment, you can get back to doing the things in life you enjoy.
Expand or Relocate your Business
Whether your current facilities are too big, too small or no longer in an ideal location, a 1031 exchange can help you relocate into that new, more desirable replacement property. The exchange allows you to defer the gain as well as the depreciation recapture so all your equity stays invested in real estate and working more efficiently for you. You can even use a 1031 exchange to split your equity towards multiple locations.
While you can no longer exchange tangible personal property, such as furniture, fixtures and equipment, and relinquishing them does create a taxable event, it is important to note that you would be eligible for 100% immediate expensing on the acquisition of new capital assets. This gives you the opportunity to relocate your business and replace equipment, fixtures and furniture to set yourself up for additional growth in 2019 and beyond.
Refinance to Accomplish Other Goals
To maximize your tax deferral in a 1031 exchange, you must reinvest all of the equity netted from the sale of your relinquished property. Fortunately, there is nothing to prevent you from refinancing after you complete your purchase which enables you to pull cash out tax-free. This cash can be used to accomplish many other objectives from making improvements to the new property, acquiring other real estate or diversifying your investment portfolio by investing in stocks, bonds or mutual funds. Some of this money could be used to pay college tuition for your child or grandchild, plan the vacation of your dreams or purchase the boat you always wanted.
Many investors are well aware that a 1031 exchange provides immediate tax deferral and is a great way to build your real estate portfolio. Unfortunately, many fail to realize that 1031 exchanges can also be used to help you accomplish many long-term objectives.