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A 1031 Exchange Doesn’t Have to Be a Fair Trade

Swap your properties and defer your taxes with a 1031 exchange

Swap your properties and defer your taxes with a 1031 exchange

Orange County, CA – A 1031 exchange is a fairly simple maneuver to delay payment of taxes. If you sell a property for a gain, you’re obligated to pay capital gains tax on the difference between your acquisition price and your sale price.

For example, if you purchased an investment home three years ago for $600,000, and then you sold that property today for $700,000, you’d have to pay capital gains taxes on $100,000. In a 1031 exchange, if you use that $700,000 to immediately purchase another investment property, you can forego the capital gains taxes. In fact, today in California, you’d also have to pay state capital gains, state affordable healthcare, and a depreciation capture tax as well. All of these taxes are sidestepped by a 1031 exchange!

How to Stack the Deal

The name “exchange” makes the whole deal sound fairly straightforward. You have money from the sale of one asset and you use it to buy another asset. Done deal. But it doesn’t have to be and this is where the fun can start.

Let’s say you have that $700,000 from that home above. You sold it because you really want to purchase a new 4-plex where you can increase the number of units for rent. This can be a much larger purchase, but there’s no rule in section 1031 of the tax code that says you have to use only the money you got from your equity withdrawal to purchase the new asset.

We can work with you to put together a mortgage that you can add to your existing 1031 exchange in order to acquire a larger, higher-quality, or otherwise more valuable property. Let’s say, for example, you get a jumbo loan of another $700,000 to add onto your initial funds. and you purchase a 4-plex worth $1.4 million. When you rent out those other units, you’re likely to cover the mortgage and turn a profit all while foregoing the taxes on $100,000.

Limitations on 1031 Exchanges

  1. You cannot use 1031 exchanges on personal property — only business and investment properties apply.
  2. There are limitations on what can be swapped for what. They’re very broad. You can trade a ranch for a strip mall or a dry-cleaning business for a taco truck but there are some traps if you’re not wary.
  3. You don’t need a specific replacement selected when you sell the first property. But you do have to give the IRS a short list (usually three) of properties you intend to choose between.
  4. Once the initial withdrawal is made, you have only 45 days to finalize your decision, and 180 days to close the deal, or you’ll get taxed regardless.
  5. No matter what you’ve heard about people using 1031 exchanges to trade vacation homes with their friends, that’s no longer allowed. Today, you must actually convert your vacation home into a rental and do business as a landlord (with tenants and everything) for a least a year before the property is considered a business asset and thus eligible for a 1031 exchange.

Contact me if you’re interested in adding a mortgage with your 1031 exchange funds to your next acquisition.

Scott Storace

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