Investing in real estate is undoubtedly the most productive way to build wealth in one’s lifetime. However, investing in real estate can often come with significant tax burdens if not familiar with real estate tax law. Investors and landlords have a powerful tool at their disposal to help mitigate these tax liabilities: the 1031 exchange. In this blog post, we’ll explore how 1031 exchanges benefit residential landlords and current real estate investors, allowing them to save millions in taxes and build wealth over time. Additionally, we’ll highlight a unique solution that we offer – debt-free 1031 exchange replacement properties that match your investment to the penny through tenant-in-common ownership.
What Is a 1031 Exchange?
A 1031 exchange, also known as a like-kind exchange, is a provision in the U.S. tax code that allows real estate investors to defer capital gains taxes when they sell one investment property and reinvest the proceeds into another property of equal or greater value. The name “1031” refers to Section 1031 of the Internal Revenue Code, which outlines the rules for this tax-deferral strategy.
The key advantage of a 1031 exchange is that it enables investors to defer paying capital gains taxes, which can be substantial, and instead, reinvest that money into new properties. Over time, this can result in significant savings and wealth accumulation. If one were to continue to 1031 exchange throughout their life, the tax liability would be completely dismissed once the individual passes, leaving no financial burden on beneficiaries.
How Does a 1031 Exchange Work?
To execute a successful 1031 exchange, you must follow specific guidelines and meet certain requirements:
- Property Identification: Within 45 days of selling your initial property, you must identify potential replacement properties in writing to a qualified intermediary. (We always have replacement properties available for your immediate identification—view our inventory here)
- Purchase Window: You have 180 days from the sale of your original property to close on the purchase of one or more of the replacement properties listed.
- Like-Kind Properties: The replacement property must be of like-kind, meaning it must be used for investment or business purposes. Residential landlords can exchange one rental property for another, for instance.
- Equal or Greater Value: The replacement property must have a purchase price equal to or greater than the property you sold. Any cash or “boot” received from the sale must be taxed, but does not blow up the entire exchange.
- Qualified Intermediary: It is essential to work with a qualified intermediary, a neutral third party responsible for facilitating the exchange and ensuring all IRS requirements are met.
How Does a 1031 Exchange Save Taxes?
The primary tax-saving benefit of a 1031 exchange is the deferral of capital gains taxes. When you sell a property, you would typically owe taxes on any profit (capital gains) from the sale. However, with a 1031 exchange, you can defer these taxes indefinitely by reinvesting the proceeds in a new property.
Let’s consider an example: You sell a residential rental property for $223,000, and your capital gains tax liability would be about $50,000. Without a 1031 exchange, you would owe this amount in taxes immediately. However, by utilizing a 1031 exchange and reinvesting the entire $223,000 into a like-kind property, you can defer the $50,000 tax bill. This allows your investment to grow over time without the burden of upfront taxes.
The Power of Tenant-In-Common Ownership
While the benefits of a 1031 exchange are clear, finding a replacement property that matches your investment criteria to the penny is very challenging. This is where Millcreek Commercial comes in, offering a unique solution through tenant-in-common (TIC) ownership. Read more about what a TIC is in this article.
With TIC ownership, you can invest your 1031 exchange funds into a property alongside other investors. This structure allows you to pool your resources, providing access to high-quality properties that might have been out of reach individually. Here’s how it works:
Matching Your Investment: In the example mentioned earlier, if you sell your investment property for $223,000, we can help you identify a Millcreek Commercial Property where your investment exactly matches this amount. This eliminates the need to invest additional funds or worry about leftover taxable “boot.”
Diversification: TIC ownership also offers diversification benefits. Instead of putting all your funds into a single property, you can spread your investment across multiple properties, reducing risk. For example, you could diversify your investment through a healthcare center in Alpharetta, GA, a daycare center in Lakewood, IL, and a dollar store in Pisgah, AL.
Passive Income: Our properties generate steady rental income, providing you with a steady stream of passive income while your investment appreciates. With rent increases and strong tenants, you will be able to purely enjoy your passive real estate investment.
Professional Management: Our TIC properties (and full-building options as well) are professionally managed, relieving you of the day-to-day responsibilities of property management. Most of our properties feature NNN leases, meaning all you have to do is enjoy your rental check every month.
In the world of real estate investment, 1031 exchanges are a powerful tool that can help residential landlords and current real estate investors save millions in taxes and build wealth over time. By deferring capital gains taxes and reinvesting in like-kind properties, investors can keep more of their profits working for them. Millcreek Commercial offers a unique solution through tenant-in-common ownership, ensuring that your 1031 exchange funds are matched precisely to your investment amount. With this approach, you can enjoy the benefits of tax deferral, diversification, passive income, and professional management, all while building your real estate portfolio.
If you’re a real estate investor looking to maximize your tax savings and grow your wealth, consider exploring the possibilities of a 1031 exchange with tenant-in-common ownership. Contact us today to discuss your investment options.