A 1031 exchange allows you to sell and buy an investment property of a similar kind while deferring on capital gains tax. For instance, as a property investor, you buy a property worth $1,000,000 in 2022, then it appreciates to $1,500,000, and you decide to sell it. In that case, the capital gain from the sale is $500,000, and you must pay the tax on that gain. But if you decide to utilize a 1031 exchange, you defer on the capital gain tax and invest the entire $1,500,000 in the replacement property.
Let’s look at the various reasons you should consider dst 1031 exchange.
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The tax advantage
The primary advantage of utilizing a 1031 exchange is the tax deferral. By carrying out a 1031 exchange, you defer on the capital gains tax leaving you with more funds in your hands to invest in the replacement property. In a 1031 exchange, you sell one investment property, buy a replacement property of like kind, and postpone the capital gains tax payment. Like-kind means that if you sell a commercial property, the replacement should be a commercial property. Rather than paying out a third of that equity in taxes, you have more funds working out for you.
Invest in a higher value property
A 1031 exchange enables you to trade up for a higher value property or a portfolio with higher return prospects, and you don’t have to pay tax on the new investment. Suppose you own a single commercial property. In that case, you can double your investment property cash flow by carrying out a 1031 exchange to trade the single commercial property with an extensive portfolio of single-family rental homes. Many savvy investors have 1031 exchanged single-family homes in high tax markets with rental properties with lower volatility and better cash flow for better returns.
Diversify your portfolio
A 1031 exchange is an ideal option, especially if you want to invest in a market with growing potential. Remember that these changes are not confined within state lines. As such, you can diversify your risk in real estate, which could lead to more significant returns in the future. For instance, if you are a passive investor, a 1031 exchange can allow you to sell a single managed property and invest in various passive investments to spread your risk across the markets and even reclaim the time lost managing property. A 1031 exchange can enable an investor to trade a high-value property with several properties with higher returns.
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You can reset your depreciation.
A 1031 exchange allows you to write off the depreciation of an asset for compensation on loss related to wear, tear, structural damage, and aging of the property. In simple words, you have the potential to minimize the income tax amount you pay due to depreciation. In a 1031 deferred tax exchange, your CPA may help you reset the depreciation amount of your investment property to a higher value giving you a more significant tax benefit.
A 1031 exchange helps you defer capital gains tax, diversify your investment portfolio, reset the depreciation clock, and invest in a property with better return prospects.