The 1031 tax deferred exchange , also referred to as a Starker exchange, is the most effective way to block the tax man while simultaneously building long term wealth.
Many real estate investors pay 20% - 25% of their capital gain in federal taxes, plus any state taxes. Taxes eat deep into business profit margins.
strategy provides the investor with the advantage of acquiring and
disposing of properties without any
payment of capital gains tax but if, and only if, there is an exchange
of "like kind" property within a stipulated period and in accordance
with US laws.
The guidelines on like types of properties are generous. Apartment buildings and duplexes can be exchanged for a Single family home rental. Raw land exchanged for rental property or residential for commercial (and the reverse)
They build wealth automatically giving both short and long term benefits with cash flow, compounding, and deferment strategies.
You'll get reduced risk.
Its difficult for judgments to be attached to an exchange property because the real estate investor never owns the property in their personal name this creates a built in
layer of asset protection.
Many investors keep rolling their deferred exchanges and never cash out because upon death their estate receives a stepped-up tax base and the deferred tax consequences are eliminated.
However, its seasoned real estate investors that know the power of leverage that love 1031 tax exchanges the most. By reinvesting the deferred tax amount into another property, they can compound the effect of the money.
The 1031 tax deferred exchange can be complicated but its easy with software. We like the Exchangor program that compares up to 4 properties at a time and with a complete analysis of the exchange property and transaction details.
Exchangor software balances equities, estimates realized and recognized gain, evaluates boots both given and received, calculates transfer basis and compares cash flow.
Use the 1031 Exchange Software to analyze the deal + use a qualified intermediary and follow the rules. When you choose an intermediary, nothing is more important than the security of your funds and the integrity of your transaction.
The intermediary plays the most important role in this process by providing investors, their legal staff, and financial advisers the level of assistance needed for a successful exchange.
The professionals do all the work, prepare the documents, and you just sign the papers.
1. Plan for the Exchange
Prior to beginning the exchange process,
consult with your tax or financial adviser to determine that a 1031 exchange is appropriate for you. If so, all you need to do is find an Intermediary who is qualified to execute the exchange.
2. Buy a property or Sell The Relinquished Property
Open an exchange order after you are in contract,
and BEFORE closing has occurred. Certain facilitation language must be added into the contract for sale. You never see, touch, or process the proceeds, instead your assigned intermediary takes care of everything and delivers all the finished paperwork back to you all wrapped up.
3. Identifying A Potential Replacement Property
A Replacement property has to be identified by the exchanger within 45 days of the sale of the relinquished property. The exchanger can identify up to 3 replacement properties without commitment.
4. Purchase The Replacement Property
A Replacement property must be bought within 180 days of the sale of the relinquished property.
Transactional costs are higher compared to a traditional closing.
Although there are no taxes liable on a tax deferred exchange you still
have to pay transactional fees as well as the fees of the qualified
legal adviser (if any).
Because there is no recognization of loss for tax exchanged properties, if your exchange property experiences a loss, the best strategy would be to sell it opposed to exchanging into another property. Then write the loss off on your taxes and start a new tax exchange.
Remember the exchange Is NOT tax free -
The name tells you that it is a deferred and not a tax free exchange. Caution, this means that if you sell your property without exchanging the gain into another like property you will indeed have to pay capital gains taxes.
PRO TIP: Since you made it to the bottom of the page, that means you are a serious investor, so here's a bonus: The Federation of Exchange Accommodators (FEA) is where you'll find intermediaries and professionals, who facilitate 1031 tax exchanges that are acceptable by the IRS