According to the Federation of Exchange Accommodators, an estimated $100 billion worth of real estate assets were exchanged through 1031 Exchanges in 2019. While this figure can vary each year depending on the economy, it’s apparent why so many real estate investors and businesses are taking advantage of this tax incentive. Here’s what you need to know to help transform your real estate strategy.

What is 1031 Exchange?

1031 Exchange is swapping one piece of real estate investment property for another, to help avoid paying or deferring capital gains tax, which is due only after an investment is sold. These taxes can be high (up to 20%), depending on the individual filing, and are owed on the profits made from the sale of assets, like investment real estate. They’re separate from regular taxable income.

To take advantage of this tax incentive, the following conditions must be met:

• The purchasing property must be equal or greater value and ‘like-kind’: Meaning they’re being used for the same or similar investment or business purpose. Commercial, residential, undeveloped, and developed property are all considered like-kind to each other. For instance, a real estate investor can buy a single-family home for $200,000, rent it for two years, and then sell it for $300,000 to put down on an apartment complex.
• An intermediary must hold the sale proceeds: The funds must be immediately deposited into an intermediary account, like a 1031 Exchange.
• The new property purchase must occur within 6 months: A new property must be acquired within 180 days of the original property transfer or by the tax return due date for the year in which the property was transferred. Additionally, you must identify a replacement property within 45 days of the original sale.

Using 1031 Exchange has been helpful for many investors and small business owners who frequently purchase property as rentals to then sell and expand into larger investment property.  

What are the benefits of using 1031 Exchange?

1031 Exchange is a way for individuals to reduce the tax burden by deferring their capital gains taxes. This often results in maximizing equity for your new property. Aside from deferred taxes, here are a few additional benefits to consider:

• Wealth-building opportunities: Without capital gain tax deductions, investors can reinvest the full amount of property sales into bigger and more profitable properties, resulting in increased assets and opportunities for wealth-building.
• Portfolio diversification: 1031 Exchanges allow investors to diversify their real estate assets without immediate tax implications. It also makes it easier to vary properties from small to large or from land to residential.
• Flexibility: It provides investment flexibility based on the investors needs or new strategies. For instance, they can consider consolidating multiple single-family homes into one and vice versa.
• Maintaining capital: By not losing a huge chunk of an investment sale to taxes, investors can put more money into a bigger or better property.  
• Increased cash flow: Investors can exchange a low-performing property for one with higher income potential, enjoying more cash flow and potentially seeing increased monthly revenue.

What are the downsides of using 1031 Exchanges?

As with everything, some processes or business strategies have downsides and may not be helpful for everyone. Here are a few to consider:

• Rules and regulations: 1031 Exchanges have an explicit set of rules and regulations with hefty tax liabilities if not handled properly. It’s important to seek advice from a 1031 Exchange specialist and tax advisor before striking deals.
• Time constraints: The strict 45-day window for identifying a new property purchase after selling your original property adds stress to an already intense process. Additionally, the entire exchange must be completed within 180 days.
• Costs and fees: While this process allows for tax deferment, it’s not a free service. Hiring qualified 1031 Exchange specialists, consultants, or legal assistants can be costly.  
• Like-kind property limitations: Investors can’t exchange just any property for another. It must meet the specified ‘like-kind’ requirements, including equal or greater value and same nature or character, meaning the new property must be for an investment or business purpose.
• Decreased liquidity: Rolling over proceeds from property to property often ties up capital and could pose challenges if an investor needs liquidity for emergencies or other business opportunities.

How does FirstBank support 1031 Exchanges?

FirstBank offers a full range of commercial products to help scale your business and 1031 Exchange services to help ensure successful tax-deferred exchanges. Here’s how:

• 1031 Corporation is a subsidiary of FirstBank. As a bank that is backed by the FDIC, your trust funds are also secure in the event of an economic disaster.
• FirstBank’s 1031 Exchange specialist team has experience handling complex, multi-million dollar exchanges across all 50 states.
• The bank maintains segregated bank accounts for each exchange to ensure the security and safety of individual trust funds.
• Additionally, FirstBank offers multiple services for personal and business accounts, making it easy to do business all in one place.

In the end.

Making wise business decisions, including 1031 Exchanges is key to long-term success. You should always consult a business advisor or tax professional before buying or selling investment properties. To learn more about 1031 Exchanges and how it can help your business grow, visit efirstbank1031.com.

For more tips and tricks, check out the Business Success page at efirstbankblog.com.

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