Partnering up with the government when playing the commercial real estate sector grows your holdings and builds your wealth. You get to hold off on paying capital gains taxes and have the money working for you. When you first hear of a 1031 land exchange, you are forgiven for thinking the process focuses exclusively on land. However, you can’t be further from the truth. A property exchange covers just about any property that has a commercial application.
As long as there’s a potential to generate an income from the said property, it’s a game in the property swap process. From ranches, agricultural firms, shopping malls, office blocks, to rental houses, anything goes. You can harness the advantages that are outlined under Section 1031 of the tax code and grow your wealth.
How does Section 1031 work?
Recognizing that the high asking prices in commercial real estate were raising the entry bar into the sector, the Internal Revenue Service (IRS) came up with an ingenious way to help investors. The section allows you to refrain from paying capital gains taxes following the sales of a property on the condition that you reinvest the entire amount in commercial real estate.
At first glance, not keeping any of the sales proceeds might seem draconian, but it gets better. IRS stipulates that the replacement property must be of equal or higher value than the current property. Now that you keep all your gains, you get to build larger equity in the new property. It means that you get to lower the amount of financing necessary to buy the new property. A smaller loan translates into paying an equally smaller amount of money in interest.
What other advantages does it come with?
In a nutshell, a 1031 property exchange is a gift that keeps on giving to the investors in real estate. For starters, if you never sell the swapped property, you can pass the deferred taxes to your children when they inherit the property. With the right kind of financing, you can buy a property that is valued as much as the current property.
Again, the replacement property can be located anywhere in the United States and can be in any commercial sector. That means that you can escape a market with high property value but low rental income. The untouched sales proceeds can go along in neighborhoods with low property prices. You can swap one property with several properties in the low-priced area. The consistent, high rental income makes up for not pocketing a cent from the sale of your property.
Swap till you drop.
There’s no limit to the number of times or properties that you can swap, so you’re free to indulge as often as you wish. Again, there are not hard requirements as to how long you can hold a property before swapping it back. IRS proposes a hold time of one year but more of a measure to try and differentiate between long-term and short-term capital gains. However, there’s no stipulation of this in the tax code.
Property swaps are increasingly becoming popular with commercial real estate investors. The process carries distinct advantages that are easy on your pocket and can help build your real estate empire. In essence, you get the government to fund some of your property acquisition.