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The scoop on 1031 Exchanges

The scoop on 1031 Exchanges

June 06, 2022

A 1031 exchange allows real estate investors to swap out an investment property for a qualifying replacement and defer capital gains tax otherwise paid at the time of sale. Real estate investing can help build wealth over time, and strategies such as exchanges push tax liabilities down the road so your property investments can continue to adapt and grow for the long haul.

Here Are 6 Advantages of 1031 Exchanges:

  1. Greater Income Potential: Sell any appreciated real property and acquire income-producing property with better cash flow and potential appreciation.
  2. Change Property Types: With 1031 exchanges, taxpayers can swap into several types of investment real estate, such as exchanging residential for commercial property.
  3. Relocate: Exchange your current property to relocate to a state with greater or lower tax rates.
  4. Consolidate: Taxpayers who own multiple properties can consolidate by exchanging them into a sole property.
  5. Exit management-intensive Properties: 1031 exchanges allow you to exchange out of properties that require a lot of deferred maintenance and into a property that is less management intensive.
  6. Level Up: Level up with a 1031 exchange by selling smaller properties and stretching your equity into larger properties with a greater potential for appreciation.

Although 1031 exchanges can be beneficial for many investors, it’s important to consider the potential disadvantages as well, so you can make an educated and informed decision.

Potential Disadvantages of 1031 Exchanges:

  1. Loss of Control: Some investors want and need to have complete property management control. With a 1031 exchange, you give up control to a national institutional property manager to complete traditional landlord duties.
  2. Properties Are Illiquid: Anyone purchasing a 1031 exchange must assume that their investment is not liquid. It is a long-term investment with an average holding period before a sale of five to ten years on average.
  3. Accredited Is Required: With 1031 exchanges, you must qualify as an accredited investor. This means your income exceeds $200,000 individually or $300,000 when combined with a spouse in each of the last two years. There is a reasonable expectation that you maintain that same income in the current year or that your net worth is over $1,000,000, excluding equity of your primary residence. These thresholds, however, do not apply for a conventual property-to-property 1031 exchange or property level-up.

 1031 exchanges can be confusing, but they can also be a strategic opportunity with the right advisor to guide you through the process. At Lam, Po & Xu CPAs, we speak finance in your language and aim to help you keep more of what you’ve achieved!

 There are risks, costs, and fees associated with all 1031 Exchanges, and the tax benefits must be weighed against the costs of the transaction. Please consult your attorney and tax advisor.