If you make real estate investments, you may consider using a 1031 exchange to minimize your immediate tax burden and maximize your investment returns. This tax mechanism allows you to reinvest your full proceeds from real estate sales. To take advantage of this tax mechanism, you will need to work with a 1031 exchange company.
What is a 1031 Exchange?
When you sell an investment real estate property, you typically owe capital gains tax on the appreciated value of the asset. However, many real estate investors intend to immediately purchase a new replacement property with the proceeds. A 1031 exchange allows investors to defer their capital gains tax until they cash out their portfolio.
In other words, if you bought a property for $400,000 and sold it for $500,000 then bought another property also worth $500,000, you would not owe capital gains on the $100,000 increase until you sold the second property. This can cause an accumulation of tax. However, it also means you can keep more of your money for making investments until you are ready to sell.
What Does a 1031 Exchange Company Do?
To use a 1031 exchange, you need to have a qualified intermediary help. This company will hold the funds from the sale of the original property (called the relinquished property) until the replacement property has been purchased. Working with a qualified intermediary, either an individual or a 1031 exchange company, is a legal requirement for using this tax mechanism.
Why Use This Mechanism?
The main benefit of working with a 1031 exchange company to facilitate your real estate sale is to defer the capital gains tax. That means that you can reinvest more of your money now and deal with the taxes later. Money now is typically worth money than money in the future.
Additionally, you can reset the depreciation clock. You can write off depreciation on your taxes each year. However, if you sell a property for more than the depreciated value, you will need to “recapture” that depreciation. Resetting the depreciation timeline helps you defer the taxable income caused by depreciation recapture.
Discover more about the value of a 1031 exchange and decide whether it is right for your real estate investment needs. This powerful tool can help you optimize your tax situation so that you can increase your wealth. This mechanism isn’t right for everyone in every situation. Knowing when to apply it will help you get the most from working with a 1031 exchange company.