Working with the 1031 Exchange: A Strategy Every Serious Ulster County Real Estate Investor Needs To Know
Congress is making drastic changes to taxes, and keeping informed is the best to make sure you’re poised to take advantage of those changes. One of the most powerful, but least known about tax advantaged investment tools for Ulster County real estate investors or owners, is the 1031 exchange. While some tax shelters and plans have been on the chopping block, 1031 exchanges are something that every serious real estate investor needs to be aware of.
What is a 1031 Exchange and How Can It Help Maximize My Investments?
Every year taxes are due, and often with assets of significant size. For individuals with high net worth, year end taxes can be a significant amount of money. Under the IRS 1031 statute, where the term 1031 exchange comes from, one can swap or “exchange” certain types of property for another, with the end result being a significantly reduced tax liability.
In certain cases, and if a 1031 is executed properly, your tax liability can be reduced to effectively zero.
The easiest way to understand how a 1031 works is that in its essence, a 1031 exchange is a deferral of taxes, and a way to avoid paying capital gains taxes on the sale of your property if the value has appreciated over the years.
While a 1031 exchange is a tremendously valuable tax strategy, it’s important that you execute it properly and adhere to all the IRS guidelines. The last thing anyone wants is to have to pay the IRS back taxes, or worse yet, experience an audit or further issue from the IRS.
So if you were to sell one property that has appreciated in value, you can avoid paying capital gain taxes by investing that money back into the purchase of another property. The 1031 is a tool that sophisticated and savvy Ulster County real estate investors use fairly frequently.
While powerful, it does require careful planning and preparation to pull off properly. A 1031 is not a shortcut by any means, and not for casual investors who are looking for a quick and easy fix. With proper planning and guidance from a 1031 tax exchange professional or tax strategy company, it’s easier than it may seem.
What are basic rules and conditions for 1031 Exchanges?
The basic rules for a 1031 exchange are: an investor will sell a property that has appreciated in value since the original purchase date, place the proceeds of the real estate sale in escrow with a third party intermediary, and then within the confines of a specific amount of time, purchase a second piece of property. It’s vital to adhere to all the conditions of a 1031 tax exchange as defined by the IRS or you risk severe penalties.
When choosing an escrow company, there are certain vital things to look for as well. It’s imperative that your escrow company is licensed, bonded, and insured as you want protect your money. Much in the same way that your bank is insured by FDIC, it’s critical to make sure your escrow company has insurance coverage for your funds.
1031 exchanges have been used by many to grow their real estate portfolios tax free, and using the tax savings as added investing power and padding their portfolios. While it may seem simple and straightforward, there is another important qualification to this tax strategy.
1031 exchanges are governed by two distinct facets that must be satisfied in order to qualify for the tax savings. First, the properties must be of “like-kind” and qualified for the 1031 exchange. Like-kind property is defined as being similar in type and nature, even if there is a difference in their quality or specifics. So two pieces of real estate can qualify for the exchange even if they’re not identical, meaning a vacant lot can be swapped for a fully built and functional home.
The second facet of the 1031 is that the property must be either for an investment or is productive from a commercial, business, or trade reason. These two qualifications disqualify personal and vacation homes because they’re typically not the type of investments the IRS intends to stimulate with this tax savings vehicle.
There are some additional restrictions and specific nuances to a 1031 that are best discussed with an experienced professional, but overall the benefits of this strategy are well worth the effort.
So whether you’re new to Ulster County real estate investing or a seasoned investor looking to maximize your real estate investing gains, the 1031 tax savings vehicle can be a tremendous tool to help you. You can stop stressing about paying capital gains and use what would’ve otherwise gone to the government to help grow your own portfolio.