Traditional sales are not the only way you can dispose of assets in real estate investing. Various other strategies provide benefits you won’t encounter in straightforward selling, and some are more suitable for certain types of investors or financial goals. One of these avenues is the 1031 Exchange, wherein you swap two like-kind properties instead of conducting a taxable sale.
The like-kind swap has gained popularity in real estate investing because it offers an array of advantages. In this article, Realized 1031 outlines the 1031 Exchange benefits you can expect through this strategy. Keep reading to learn more.
1. Tax-Deferred Real Estate Investing
The top advantage of 1031 Exchanges is how it allows investors to sell assets and acquire new property without the burden of capital gains taxes. In a taxable sale, you could end up paying up to 20% of the total sales price.
A 1031 investment strategy lets you swap two properties without an official sale. Thanks to this mechanism, you can defer capital gains taxes and depreciation recapture. You can reinvest all your proceeds. If you keep exchanging, the repeated deferrals can dramatically compound portfolio growth.
2. More Equity for Portfolio Growth
As you preserve your equity, you also increase your buying power. Leveraging more of your capital enables you to access higher-value properties than in traditional sales. More of your equity works for you instead of ending up with the IRS.
With the increased buying power, you are in a better position to grow your portfolio. You can transition from small multi-family units to larger townhouses or apartment complexes, for example. This benefit helps you accelerate wealth accumulation and scale your real estate holdings more efficiently.
3. Market Flexibility
Portfolio restructuring can be expensive and complex if you rely solely on traditional methods of property disposition. However, this practice becomes necessary as you respond to changing market conditions, financial goals, or personal circumstances. 1031 Exchanges, through tax deferral, provide the flexibility you need as you reposition your portfolio.
Thanks to the lowered costs brought about by delayed tax liability, you can more easily leave an underperforming property or a volatile sector and enter ones that offer growth and stability. You remain agile and lower risk without triggering a heavy tax burden.
4. Diversification Through DSTs and TICs
1031 Exchanges aren’t limited to sole direct property ownership. Delaware Statutory Trusts (DSTs) and tenancy-in-common (TIC) arrangements provide varied ownership structures as well as enhanced diversification.
- DST: These trusts typically own multiple properties across various sectors or geographic locations, ensuring that even if one property underperforms, you can maintain steady cash flow. DSTs also provide access to institutional-grade assets like Class-A office buildings, big-box retail stores, and logistics hubs.
- TIC: Under TIC arrangements, you can pool your proceeds to acquire institutional-grade assets that have higher earning and appreciation potential. Direct ownership doesn’t usually provide this benefit for small-time investors.
5. Fewer Management Responsibilities
For retirees and investors who want fewer responsibilities over their assets, 1031 Exchanges allow you to acquire property that helps reduce hands-on management. While the like-kind swap still lets you directly own an asset, arrangements like NNN leases allow for diminished responsibilities while maintaining predictable income. DSTs, meanwhile, are totally passive in nature. For those who simply want to earn income regularly without having to consider management, tenant relations, or day-to-day administration, DSTs are the ideal indirectly owned investments.
6. Benefits for Estate Planning
1031 Exchanges provide two key benefits for estate planning.
- Ease of Asset Division Among Heirs: DST and TIC interests bring about this benefit. These assets are easier to appraise and divide among heirs because they’re securitized fractional interests. Each heir can receive a specific percentage-based portion, which is difficult to do with directly owned properties.
- Step-up in Basis: 1031 Exchange assets qualify for a step-up in basis. Upon your passing, the cost basis of the property is reset to its current value, eliminating all accrued capital gains taxes. If your heirs decide to sell after your passing, then they won’t have to deal with a major tax burden.
Wrapping Up: Real Estate 1031 Exchange Advantages
Many investors have been drawn to 1031 Exchanges because of the varied like-kind exchange benefits. From tax-deferral to portfolio flexibility, from enhanced diversification to estate planning advantages, the pros are numerous. The powerful mechanism helps you preserve wealth, optimize cash flow, and transition from active management to passive investing with ease.
Sources:
https://www.investopedia.com/terms/t/tenancy_in_common.asp
https://www.delawareinc.com/blog/what-is-a-delaware-statutory-trust/
