Wait! Don’t Sell Yet…
1031 Exchange for the Modern Investor
If you’re to the point in your investing career where you’ve started buying and HOLDING, then you may need to learn a thing or two before you start shuffling your properties around. Instead of flailing around and making mistakes with large numbers, get to know your options.
If you’re selling an investment property with the intention of purchasing another and you don’t know what a 1031 tax exchange is, then sit down. Let’s chat…
A note: As the CEO of The Lee Arnold System of Real Estate, I do not often wear my “buy and hold” hat. I rarely recommend this as an investment option until you’ve reached a certain level in my Circle of Wealth. However, I still recommend this service for those who are buying and selling rentals.
And since Cogo Capital® doesn’t just offer quick turnaround, excellent terms, and millions to lend to investors, our loan officers would be happy to talk to you about your upcoming transitions.
If you’re ready to learn more about the CIRCLE OF WEALTH, click here.
How do you know if a 1031 tax exchange is the right move for you? First, let’s make sure you know what it is and the details of how to make it work for you.
WHAT IS IT?
This strategy allows an investor to “defer” paying capital gains taxes on an investment property when it is sold. Basically, when you sell an investment property you currently own (such as a rental), you can then purchase another property of “like-kind” (equal or greater value is preferred, we’ll go over that), and can do the exchange in your portfolio without paying capital gains.
So, if you have a property with plenty of equity and you want to use that as profit to purchase another property, that’s what this is for.
Why would you want to exchange properties?
- It’s in a city or state in which you no longer live, and the care for that property has become a burden.
- You want to upgrade from a smaller rental (a duplex to a four- or six-plex).
- Your market is shifting, and you want to take advantage of the greater opportunity.
- And many more reasons…
Traditionally, 1031 exchanges were used to quite literally swap one property for another of like-kind. Since the market has changed and morphed into something completely new since 1031s came into existence, it is now more likely you will find a property that is different than your current one. You may think this makes things tricky, but the process is still quite simple.
Simple or not, you need to know what the process looks like if you’re going to attempt it. But if you can refocus your investing without incurring tax liability, then it’s worth the due diligence. Whether you’re changing from a low-income (and therefore high-maintenance) property to a better one, or you’re switching locations, you shouldn’t need to pay significant taxes because of properties you purchased in the past.
The 1031 makes this possible.
WHEN TO DO ONE
Even if you didn’t initially purchase a property, you’d pay capital gains if you don’t do a 1031 exchange. So, if you’ve made some less-than-par investments (or if you’ve just had some bad luck), you can sell the investment without tax loss.
If you don’t know about this strategy, you may end up owing more than you made.
But, utilize this strategy, and you can be swimming in profit from a property that has appreciated. So, how do you use a 1031 tax exchange?
Plan for Your Loan
First, plan your move by exchanging one property for another property of similar value, Yes, step one is to plan, because although you may think you can just swap a house for one of equal or greater value, you still need to qualify for that much or more.
For instance, let’s say you purchased a rental property with the intention of occupying one of the units. Because it was owner-occupied—even if you’ve moved on since—you got that $400,000 loan with less money down. Now, with your financial landscape on a different field entirely, you can’t qualify for more than $350,000, especially since you’ll have to put 20-25% down. That’s great if you’ve amassed enough equity and have the funds, but until you know what you qualify for, you can’t just make assumptions.
To maximize your 1031, if you can’t qualify for at least the amount of your current properties, it may be wise to consider other options. Otherwise the tax deferment won’t make sense. (You can go slightly under, and we’ll talk about that later.) You could cash out and do a few private money loans with your money (your “skin in the game”), profit on a few deals, and then purchase big again.
To best understand this strategy, let’s discuss the four types of a exchanges for real estate, so you’re armed with the information you need before considering if this is right for you.
1- Simultaneous Exchange
A simultaneous exchange is just what it sounds like; it’s where the replacement property and relinquished property close on the same day. Any delay, no matter how brief, can result in disqualification and immediate application of full taxes.
There are three basic ways that a simultaneous exchange can occur.
- The two-party trade, completed by the owners who, essentially, “swap” deeds.
- The three-party exchange, completed when an accommodating party facilitates the transaction for the exchanger.
- Or a simultaneous exchange with a qualified intermediary who structures the entire exchange.
2- Delayed Exchange
The first type of exchange isn’t as common as this one. A delayed exchange between like properties is more frequently used by investors. In this case, the investor sells or relinquishes the original property before acquiring the second.
The investor has 45 days to identify a replacement property after selling the first and has 180 days following that to complete the sale of the property. The extended timeframe and numerous tax benefits make this options the most popular.
3- Reverse Exchange
If you identify a replacement property before the first is sold, you can, in theory, “buy now and pay later.” It doesn’t work that simply, but you get the idea. A reverse exchange (or forward exchange) is accommodated with the titleholder identifies a replacement property first.
Before you do backflips with excitement that you can acquire a property without having to pay anything now, you will need all cash when making this exchange. Because many banks won’t offer loans for reverse exchanges, this can be tricky. You must start by identifying which property (or properties) you wish to relinquish from your portfolio.
Because it’s basically a delayed exchange in reverse, the rules are similar to the delayed exchange, you have 45 days to identify the property you will sell as the “relinquished property,” and then you have 135 days to complete the sale and avoid taxes and potential penalties.
4- Improvement Exchange
Let’s say you’ve identified a replacement property but it needs work. You can truck along with one of the first two options, or you can maximize your strategy by using an improvement exchange. This exchange, also known as a construction exchange, allows you to improve the replacement property by using the exchanged equity from the first.
This method, even more than the ones before, requires finesse. First, you must spend the entire exchanged equity on completed improvements or down payment by the last of your 180 allowed days. You must also have this property identified within the 45 day period required above, and the replacement must be of equal or greater value when deeded to you. Before you can take the title back from the qualified intermediary, all improvements must be finished.
This probably doesn’t scare YOU. If you’ve ever done a fix and flip, you know that time is of the essence for repairs, so 180 days should be nothing to you, especially if you’ve gone through any training with The Lee Arnold System of Real Estate. If you’re trained right on how to manage these projects, this is a valid option.
If you need to get plugged into a quality education that will prepare you for project management, help you understand and acquire private money loans, show you what to look for and more, then you’ve got to start somewhere. With so many options, why not consider one that has your best interest at heart?
You need a place to start. Go to FundingTour.com to learn more.
Instead of cashing out and paying taxes, trade without the obligation and you can maximize your portfolio. But just because you know the four main types, do jump in with both feet just yet! Next week, we’ll talk about the rules you need to know to make this exchange as smooth and profitable as possible.
Join us next time for more, but you don’t have to wait to talk to a loan officer about your deal! If you have a house under contract that you need a private money loan on, you came to the right place. As a full-service Private Money lender for real estate investors, we do most of the leg-work for you, while you build up your real estate portfolio and cash-flow all your deals.
To Your Success;
Lee A. Arnold
The Lee Arnold System of Real Estate Investing
Have a deal under contract that you would like a quote on? Let us know. You can fill out a quick questionnaire at CogoCapital.com to receive a rate quote via email or you can call us anytime at (800) 747-1104 to talk to a loan officer. With millions deployed and millions to deploy, we want you to get the capital you need for your real estate investing.
Timothy just left a new 5-star review of Lee Arnold System of Real Estate Investing:
I would highly recommend this company to all first time investors that I come across that seek funding. I enjoyed the entire team that was out in Milwaukee to train those of us in attendance.
Gary Meyers and Jarrod done a wonderful job during this weekend. I really enjoyed the bus tour to the properties in South Milwaukee. Secondly, it’s a faith based company and this is very rare in the business and I see that God has blessed and will continue to bless those around Lee Arnold.
This is an education company as far as Real estate, training and funding. I wish I had met these guys a little earlier before I actually invested with the other companies which I won’t name. I am currently in debt to the tune of $100K due to the other companies. If I known what I know now, I could have bought 10 homes and be on my way to financial freedom.
I would like to thank the entire team that was in Milwaukee for the weekend for a wonderful experience and I hope that we meet again.
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