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Most investors are familiar with the concept of 1031 tax differed exchange of real estate. It is a section of the IRS tax code that allows a person to exchange for like property and not have to pay the tax on the money earned on the old property. There are many misconceptions however about 1031 tax exchanges so I am going to let you in on some of the details of a tax exchange.

The very first thing I have to tell you is that this gets very complicated and I am trying only to give you the broad strokes. If you would like to execute a 1031, you will need to give Shea or I a call so we can help you with the details so ensure that you don’t get hit by Uncle Sam at the end of the year.

Now, most people hear that you have to exchange for like property and they think you have to find someone who has a retail building and trade your retail building for it. That would mean that if you have a duplex you wouldn’t be able to trade into a retail building you would be stuck in the multi family market if you wanted to defer the tax money. This is not the case, and in fact you don’t really have to trade in the most common sense of the word. If you own any investment property (and have owned it for at least a year and a day) you can “exchange” into any other investment property simply by selling your property, buying a new one (within the alloted time), and declaring the gain on your old property as a 1031. Again this already can get complicated so call or email if you need more detail.

Next, when doing a tax deferred exchange you must always trade up and borrow up. What I mean by this is that you must borrow more money than you owe on your current property and you must buy a property that is worth more. The IRS gives you this incentive to keep your money in real estate in the hopes that you will keep increasing your investment. If you owe $100,000 on your investment (for example) and you only borrow $90,000 on your next you will be required to pay taxes on the $10,000 that you kept. Wait… I didn’t keep money I just borrowed less right? No the IRS sees it as a “boot” when you do not borrow at least what you owed, because they see it as a down payment on the next loan and therefore money you kept. So always borrow more and buy a more expensive property if you want to defer all of the taxes.

The last thing I am going to go into is the depreciation. Real estate as you know has always been and I believe will always be an appreciating asset. By this I simply mean that property will become more valuable over time with reasonable upkeep. Even in the softening market we will see appreciation, you just have to remember that real estate is a long term investment. The IRS however lets you take a deduction on your taxes to depreciate your investment property. If you are depreciating an investment and you 1031 the money the IRS will even let you depreciate the new property regardless of the type of investment property it is. The IRS doesn’t let you take a depreciation on raw land for example, but they will if you 1031 out of a retail complex into land.

Now if this has confused you don’t worry, email or call us we can get you through it. Shea even teaches a class in 1031 exchanges and would be more than happy to explain them to you. We also have several great 1031 exchange opportunities if you are reading this and realizing that it may be time to sell your investment let us know. We will market your property and get you into a new investment with little to know tax hit.

Let us help you get out of the rat race and into the cash flow.