The 1031 Exchange allows landlords to sell their highly appreciated properties without paying a dime in capital gains taxes. It sounds almost too good to be true, so it must be complicated, right?
It can be, but it doesn’t have to be.
“One of the biggest challenges people have with a 1031 Exchange is the short timeline that the IRS gives them to find a replacement property,” Nelson Brothers Professional Real Estate principal Brian Nelson explains in the final installment of his “Ask the Brothers” video series. “So a lot of people feel trapped.”
After a property is sold, the seller has 45 days to identify the replacement property that they want to move their money into to satisfy the 1031 Exchange. They also must close escrow on the replacement property within six months of the original sale date.
“That’s where our company can be a tremendous help,” Nelson says. “One of the biggest benefits of a Nelson Brothers property is the turnkey element of it.”
In other words, part of the beauty of investing in professionally managed real estate is that the difficult groundwork has already been done.
Understandably, the strategy has been growing more popular among mom-and-pop investors. The number of individuals who have completed a 1031 Exchange has increased every year from 2008 to 2013, the most recent year that data is available, according to the IRS.
There is another important rule governing the 1031 Exchange. To completely avoid paying any taxes upon the sale of your property, the IRS requires that the purchase price of the new property and the new loan amount be equal to or greater than the original sale price and the original loan amount.
So, for example, if you sold a property for $1 million and your investment in a replacement property is $500,000, you would need to pay the capital gains tax on the $500,000 gap.
But an investor with Nelson Brothers might have as many as four or five different properties to choose from.
“So if he has $1 million in equity, he has the ability to diversify that into two, three or four different properties all around the country and be better diversified both geographically and also by strategy,” Nelson says. “He could have a brand-new property that is focused on staying full and maintaining really stable income. He could have another property that is really value-added that might have a growth element to it.”
“The diversification element and the timing element and the ability to go into three or four different properties and actually start accruing income and to close escrow long before the 45-day window even comes up are all very compelling benefits.”