It’s Tax Season: Here’s How the 1031 Exchange Can Help

April 5, 2022

The 1031 Exchange is a tax program where the government rewards people for reinvesting into real estate. Now that tax season is upon us, it’s time to consider how this program could help you save money.

What is the 1031 Exchange?

The 1031 Exchange is a tax provision geared towards real estate investors. The government rewards investors who reinvest their gains into another property. When the investor successfully swaps (or exchanges) properties, capital gains tax is deferred. Any tax due for capital gains stays deferred until the investor cashes out and stops exchanging properties.

There are regulations within the 1031 Exchange that an investor needs to follow. For instance, the next property invested in needs to be equal or have greater value than the previous one. Additionally, vacation homes are limited, but the amount of times that somebody could use the 1031 Exchange is unlimited.

This article is intended to show you concepts that might be applicable to your real estate investment journey. It’s important to note that Sundae does not provide legal, tax, or investment advice. This material is for informational purposes only. It has been prepared without regard to the individual financial circumstances and objectives of persons who receive it. Please seek the advice of an attorney, tax professional and/or financial advisor for guidance to properly evaluate particular investments and/or strategies.

Understanding the 1031 Program

If you think the 1031 program suits your needs, that’s great! However, it’s important to cover the basic rules so you know what’s allowed. Here are three main rules to follow regarding the new property:

  • It should be equal or greater than the one being sold
  • The new property has to be identified within 45 days
  • Within 180 days, the new property has to be purchased

Now looking at the second rule, the 45 day window is pretty tight. As a real estate investor, you need some quick thinking, but you also need to plan ahead. It’s important here to be resourceful by thinking outside the box. Consider looking at options where you can get something under contract quickly to get a deal done. Looking at off-market deals is one potential solution.

Increase your leverage

Investors benefit from acquiring more valuable property with deferred taxes. In return, you could leverage the cash that would have been spent on taxes. Cash could be spent on a down payment to strengthen their purchasing offer and secure their property. Furthermore, a larger down payment means that investors will be reducing the principal amount on a mortgage, which will lower the amount of interest paid over a long period of time.

The extra money from the tax deferment also gives an investor the freedom to make renovations. Home improvements on the new property adds value which will result in maximized profit once it’s time to sell. The 1031 program gives leverage to investors by allowing them to use cash spent up front on taxes on wealth building strategies.

Real life monopoly

Plenty of real estate buyers opt for rental properties because of cash flow. As you trade up from one property to another, you may eventually find yourself in possession of a property that has dozens of tenants under one roof.

The 1031 program provides the opportunity to swap properties with tax deferments and increase the amount of doors in a given property. Perhaps you trade a fourplex for an 8 unit multifamily. Consider the possibilities as you keep repeating this process.

Flexibility

Exchanging properties without paying the capital gains tax means that investors could keep their eye on other markets. The housing market changes all the time. For instance, Austin, Texas became one of the hottest housing markets in 2021 over traditional giants like New York City.

Knowing that you can swap properties anywhere in the U.S. means that you can invest in any market with upside. Investors that are capable of investing anywhere sell when the time is right and find buy-low opportunities. The 1031 program offers flexibility instead of holding a sinking property for too long.

Legacy wealth

Some investors may worry about tax complications after death. How do loved ones take on the burden of an estate or even multiple properties? Investors who have deferred taxes thanks to the 1031 program can leave their property to an heir tax-free. Even if they sell the home for the same value, they won’t pay a capital gains tax on it.

Gains associated with the investor disappear at the time of their death. It’s a considerable benefit for anybody who invests in real estate with the idea of leaving property behind for an heir.

Will you take advantage of the 1031 Exchange?

The 1031 program is in place to stimulate the economy and reward investors. By taking advantage of the 1031 Exchange, you could spare your finances with legitimate tax breaks. Even though it will take some time to understand the regulations behind the 1031 program, it could build up your wealth quickly.

Sundae’s Marketplace helps investors make deals happen. You could benefit further from no additional fees as we provide an off-market real estate experience. Get the maximum exposure with people buying and selling so you could find the deal that suits you best.

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Erin B

Erin Behan is a writer and editor covering real estate investor strategy for Sundae. She's lived in L.A., New York, and Atlanta and currently resides in Portland, Oregon, where she writes and edits for a number of outlets, including WebMD, Farmers Insurance, and Vox Creative. She spends her free time hiking with her two boys, snuggling with her cat, and enjoying the best of the Pacific Northwest.