Investing in hotels and real estate continues to be one of the best ways to build your wealth, grow your portfolio, and minimize your taxes. Thanks to Section 1031 of the Internal Revenue Code, investors are able to enjoy these advantages.
What Is Section 1031?
Section 1031 of the Internal Revenue Code allows an owner of any business or investment property to defer paying federal capital gains taxes and depreciation recapture if they exchange business or investment properties of like-kind. The 1031 Exchange allows you to swap properties or businesses while ignoring the taxable gains and reinvesting it into more valuable property. Essentially investors are using money that would otherwise be due in taxes to continue funding a bigger portfolio.
What are the Benefits?
There are numerous benefits that can be the result of a 1031 Exchange, but there are a number of requirements that must be met in order to complete an exchange. The most obvious benefit of a 1031 Exchange is tax deferral. The true power, though, lies in what comes as a result. Depending on your investment objective, a 1031 Exchange offers a wealth of opportunity.
If you are looking to preserve your equity, a 1031 Exchange can do that. Tax deferral will allow your initial investment to continue to grow. And since there’s no limit on how many times you can do a 1031 Exchange, you can defer indefinitely and continue to reap the benefits.
Or if you’re simply looking to increase your purchasing power, a 1031 Exchange can do that too. By allowing you to use all the sale proceeds- money that would otherwise be tied up in taxes- you can leverage it into more valuable real estate, which can subsequently increase the return on your investment by producing more cash flow and greater depreciation values.
And if you’re looking to diversify your portfolio and improve your investment position, a 1031 Exchange can do that too! Although this tax provision is limited in scope to only property located within the US, diversifying into different geographic regions or into different types of business or investment properties may be desirable for you or your business.
But if you’re looking to split up property or consolidate properties, a 1031 Exchange can do that too! Allowing you to roll over the gain from property to property, gives you the option to exchange a large property and split up the gain among several smaller properties or to exchange multiple properties and consolidate the gain into one larger property.
Is it Right For Me?
A 1031 Exchange may be just the thing if you are intending to sell business or investment property, and you plan to buy business or investment property of like-kind, within 180 days following the closing of your relinquished property.
It is ideal for taxpayers looking to sell their appreciated property–a low tax basis, business or investment property that has been held for more than one year. However, it should not be utilized if you have recently refinanced the property you want to sell, nor is it recommended if the transaction will result in a capital loss.
It’s important to know, though, that 1031 Exchanges are subject to strict rules. And depending on the type of transaction involved, these can sometimes be very complex. However, the use of a qualified intermediary to coordinate the essentials is imperative to the success of any exchange. Despite its complexity, though, 1031 Exchanges remain a very powerful investment strategy- that allows ‘real estate to help defer your tax obligations!