The 1031 Exchange: Maintaining Wealth Through Passive Management

Posted by David Wieland on Jun 8, 2020


When individuals are younger, investment goals typically focus on wealth creation. In this situation, investors are able, and willing, to take on higher risk, with anticipation of higher rewards. Investors have a longer life span to experience the ebbs and flows of a capital market, and their risk appetite can prove very rewarding in the long game, albeit volatile in the short. 

As individuals approach retirement, however, the goal shifts to be wealth preservation. If an investor owns real estate, this might be the time during which he or she decides to sell the asset(s), with the idea that the illiquid real estate can be converted into higher liquidity, without much loss of value.

In truth, the value of real estate can erode with a sale, due to market conditions, asset demand and taxes incurred on profits. For example, profit obtained from the sale of an apartment complex can be taxed up to 30%, due to capital gains taxes.

The Investment Property Wealth Management™ program was created to help investors maintain wealth and receive ongoing income, especially as they approach retirement. The tool used to move investors from direct real estate management into passive real estate ownership is the 1031 Exchange. By “exchanging” from one property to another, individuals can defer capital gains taxes, while maintaining the value of their investments.

How it Works

The exchange program name is taken from Section 1031 of the U.S. Internal Revenue Code, which covers the transfer and capital gains tax deferrals of most tangible assets. Through a 1031 Exchange, a real estate investor can sell a property, park the proceeds with a Qualified Intermediary (QI), target a like-kind property of equal or greater value, then direct the QI to acquire the property. When done correctly, the exchange means a tax deferral on capital gains.

But many investors don’t have the time or expertise to both sell and buy like-kind properties within the 180-day deadline mandated by the IRS. This is where the IPWM™ professionals step in. These professionals have the know-how to sell an investor’s real estate, and target the right exchange property to avoid capital gains taxes. Furthermore, the IPWM™ professionals use their skills to build diverse portfolios based on the Modern Portfolio Theory, managing risk and preserving wealth by sheltering cash flow.

Preserving Wealth, Across Generations

The 1031 Exchange process does more than help defer capital gains taxes. The process also means that an investor’s heir doesn’t have to pay capital gains taxes, once he/she inherits the property portfolio.

If the heir decides to sell the portfolio, he/she won’t have to pay capital gains taxes on the proceeds. Upon the investor’s death, the property within the portfolio undergoes a step-up in basis, and is valued at the fair market price (rather than the prices of the properties when acquired, or exchanged). As such, step-up wipes out appreciation, meaning the heir is not required to pay taxes on profits. 

The takeaway here is that the sale of a real estate asset in an effort to preserve wealth doesn’t necessarily mean that erosion of wealth comes into play. IPWM™ relies on the 1031 Exchange process to help ensure that taxes are minimized and asset value preserved, allowing the investor, and his/her heirs, to maintain, and benefit from, wealth.

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