One of the biggest cuts from the profit margin on a real estate investment are the taxes that must be paid after selling a property. Fortunately, there is a way to defer these taxes that many real estate investors have been using since 1921, called the 1031 tax exchange. It’s a popular and straightforward strategy that is perfect for investors who are looking to reinvest and upgrade their properties. This method is one of the most effective ways to build wealth and is something that every real estate investor should understand.
What is 1031 Tax Exchange?
A 1031 tax exchange gets its name from Section 1031 of the U.S. Internal Revenue Code, which allows you to avoid paying capital gains taxes when you sell an investment property and reinvest the proceeds from the sale. The 1031 tax exchange allows you to swap out an investment property for another of equal or greater value and defer capital gains or losses that you otherwise would pay at the time of the sale. If you are looking to upgrade properties without being charged taxes for the proceeds, then you can use the 1031 tax exchange.
Role in Commercial Real Estate
1031 tax exchange offers solutions that can be used for various commercial real estate properties, including apartments, hotels, office buildings, gas stations, parking garages, and much more. In commercial real estate, a 1031 tax exchange allows you to delay paying capital gains on a property sale, so technically you can buy bigger or better commercial properties without paying capital gains taxes. It’s an investing strategy that can help you accumulate wealth.
Capital gain tax can have a huge impact on a deal’s profit margin, it can dramatically decrease it. Upon selling a commercial property, profits can impose a huge tax burden that can hinder profits. For example, let’s say you purchase a commercial property for $1 million and sell it for $1.5 million, then the financial gains subject to tax would be $500,000. That’s where the 1031 tax exchange comes in, minimizing the impact of taxes on the deal. With this method, you can use that $500,000 to buy one or more investment properties without having to pay taxes at the time of the sale.
What Investors Should Know
- It is possible to do a 1031 tax exchange with a single property or sell multiple properties in exchange for one or more commercial properties. 1031 tax exchange can be used multiple times, there’s no limit, if correctly executed.
- It’s impossible to avoid capital gains taxes completely, a 1031 exchange delays the payment of these taxes until the investment is liquidated.
- You can only perform a 1031 tax exchange between investment properties therefore you can’t use it on personal properties.
- The equity of the new commercial property should be equal or greater value to the equity of the original asset.
- You will have bigger buying power. 1031 tax exchange allows you to use money that would otherwise be paid to the IRS to invest in a new commercial property with a higher value.
Protect Your Commercial Real Estate with Express Title
The 1031 tax exchange strategy offers many benefits especially for commercial real estate investors looking to increase profit margins. If you are interested in learning more about the commercial real estate industry and title insurance, our team at Express Title can assist you. We can help you understand more about this industry, and help you make the right decisions to support your financial growth. Contact us today!