How Leveraging a 1031 Exchange Strategy Can Help You Achieve Your Commercial Real Estate Goals
A 1031 exchange is a real estate investment tool that allows investors to exchange an investment property for another “like-kind” property while deferring capital gains tax on the profit from the sale.
As a commercial real estate investor, you’re probably familiar with the concept of a 1031 exchange, but do you fully understand how this tax benefit can be utilized as a tool to achieve other goals?
In this article, learn more about the many strategies that leverage this powerful tool.
Build a Portfolio/Leverage Up
With a 1031 exchange, investors can continually reinvest the net proceeds from their assets to trade up into larger investments creating “leverage” and increasing purchasing power. By reinvesting the dollars that would have been used to pay capital gains tax, investors increase purchasing power and subsequently, build wealth. Additionally, this increase in equity can lead to a lower loan-to-value ratio when acquiring a higher-value property. This strategy can be repeated indefinitely and used with other tax strategies to build a portfolio.
Diversification by Market or by Asset Type
Owning too much of a particular asset type or having assets concentrated in a single market can pose a risk. A 1031 exchange can be used to facilitate portfolio diversification. Additionally, suppose a specific asset type is underperforming due to market conditions. In that case, a 1031 exchange can facilitate the acquisition of an asset type that is performing better, or it can be used to purchase an asset in a market that is experiencing growth.
Consolidation
Owning multiple properties increases maintenance and administrative responsibilities. Think about big-ticket items such as parking lots, roofs, and windows – and the time, resources, and expense. Consolidating several assets into a single asset can reduce both liability and responsibility.
Management Relief/Quality of Life
Not all commercial properties are created equal when it comes to management. After all, the management of a multifamily property can look vastly different from other commercial properties. There may come a point when an investor seeks to be less hands-on with their properties. In these instances, investors can use a 1031 exchange to find a replacement property that offers the prospect of a long-term net lease, where tenants are responsible for most maintenance responsibilities or the expense of hiring a professional property management company, creating predictable and consistent rental cash flow, while still having the potential for equity growth.
Relocation
From better market conditions to retirement, there are a myriad of reasons why relocation is necessary. No matter the circumstance, you can utilize this strategy to acquire another asset in a new location without being penalized.
Cash Flow
Is your current investment underperforming? If you are looking for a better-performing asset, this strategy will allow you to do so without the tax consequences of a sale.
Estate Planning
Believe it or not, a 1031 exchange can be used as a strategy for estate planning. Because there is no limit for 1031 exchanges over a lifetime, one can continue to defer capital gains and transfer assets until death. At such point, the heir would inherit the properties on a “step-up” basis and instead pay taxes on the fair market value of the portfolio, rather than the lifetime of deferred gains. This “swap until you drop” strategy builds generational wealth.
If you have questions about 1031 Exchanges, contact a licensed REALTOR today!
