Everyone wants to make money. How do investors make money in Real Estate? By using the power of leverage! Best ways to make money are 1) deferring payment of taxes on your capital gain and 2) taking said tax-deferred money and re-investing it into a larger or more properties, so you can further leverage to gain equity. This is what is known as a 1031 (IRS code) Deferred Exchange.
As the property is an investment property and not your primary residence, you cannot avoid paying taxes on your gain. However, because you are able to utilize this IRS code, you can defer (not avoid) paying taxes over and over until you decide at some point to cash out.
There are four basic requirements (simplified for explanatory purposes) to keep in mind when doing a 1031 exchange:
1. Like kind property/ies – the property that you want to next acquire with the proceeds from the sale must be of ‘like kind” meaning it/they should be used for the same purpose. Hence, all real estate (within the U.S.) fall into the “like kind” category.
2. Timeline – there is a requirement that the purchase of the next property/ies must be completed within 180 days from the sale of the original property.
3. Identification Rule – within 45 days of selling the original property, you must identify 3 properties of any price within the U.S. (of which you must purchase at least one) then complete the purchase by the end of the 180 days.
4. 100 % tax deferral – to get the full deferral, two requirements must be met:
a. Reinvestment - all of the cash generated from the sale must be reinvested into the like kind property.
b. New property must be equal to or greater in value than the property just sold.
The key to remember here is utilizing the power of leverage. The money that you would have to turn over to the IRS as capital gains tax is being reinvested and further leveraged to increase your purchasing power.
Let’s see this in action.
Investor A sells his investment property and received $800,000 for the sale. He will pay his capital gains tax (45% [both state and federal] for purposes of simplicity) and be left with $440,000 which he then can use to acquire another piece of property. Requiring 20% down to acquire another property, he can leverage his $440,000 and at most, purchase a property worth $2,200,000.
Investor B sells his investment property and received $800,000 for the sale. He decides to do a 1031 exchange, so he does not touch any of the proceeds and reinvests the entire $800,000. Using $800,000 as a down payment, he can acquire two properties at $2,000,000 each or $4,000,000 in total.
By utilizing the 1031 exchange, Investor B was able to purchase $1,800,000 more in property, starting with the same $800,000 in proceeds. Imagine the next exchange; Investor B can easily purchase 4 properties from the sale of his 2 properties.
Get the idea about how much more property an investor can acquire by deferring the capital gains tax?
To learn more in detail about 1031 Exchanges, please contact me.
Steve Mun, Silicon Valley Realtor
www.stevemun.com
As the property is an investment property and not your primary residence, you cannot avoid paying taxes on your gain. However, because you are able to utilize this IRS code, you can defer (not avoid) paying taxes over and over until you decide at some point to cash out.
There are four basic requirements (simplified for explanatory purposes) to keep in mind when doing a 1031 exchange:
1. Like kind property/ies – the property that you want to next acquire with the proceeds from the sale must be of ‘like kind” meaning it/they should be used for the same purpose. Hence, all real estate (within the U.S.) fall into the “like kind” category.
2. Timeline – there is a requirement that the purchase of the next property/ies must be completed within 180 days from the sale of the original property.
3. Identification Rule – within 45 days of selling the original property, you must identify 3 properties of any price within the U.S. (of which you must purchase at least one) then complete the purchase by the end of the 180 days.
4. 100 % tax deferral – to get the full deferral, two requirements must be met:
a. Reinvestment - all of the cash generated from the sale must be reinvested into the like kind property.
b. New property must be equal to or greater in value than the property just sold.
The key to remember here is utilizing the power of leverage. The money that you would have to turn over to the IRS as capital gains tax is being reinvested and further leveraged to increase your purchasing power.
Let’s see this in action.
Investor A sells his investment property and received $800,000 for the sale. He will pay his capital gains tax (45% [both state and federal] for purposes of simplicity) and be left with $440,000 which he then can use to acquire another piece of property. Requiring 20% down to acquire another property, he can leverage his $440,000 and at most, purchase a property worth $2,200,000.
Investor B sells his investment property and received $800,000 for the sale. He decides to do a 1031 exchange, so he does not touch any of the proceeds and reinvests the entire $800,000. Using $800,000 as a down payment, he can acquire two properties at $2,000,000 each or $4,000,000 in total.
By utilizing the 1031 exchange, Investor B was able to purchase $1,800,000 more in property, starting with the same $800,000 in proceeds. Imagine the next exchange; Investor B can easily purchase 4 properties from the sale of his 2 properties.
Get the idea about how much more property an investor can acquire by deferring the capital gains tax?
To learn more in detail about 1031 Exchanges, please contact me.
Steve Mun, Silicon Valley Realtor
www.stevemun.com
1 comment:
The best way to play the game is to use 1031 exchanges, but not many people know how to work the deal.
DeferEm.com is one of the best resources for being able to understand the tedious stuff – boot, taxable gain, deferred gain, and new cost basis – and it has a free tool you can use to generate IRS Form 8824 for properly reporting Like-Kind Exchanges on your tax return. Defer'Em is a guided approach that helps you optimize deferrals using all deductible closing costs and exchange fees, and it also generates an Exchange Report which will help you visually understand all the elements of your 1031 exchange.
Another benefit is that you can play with the numbers and get familiar with different exchange scenarios, so even if it's going to be a while before you play the capital gains game, you can always practice… just remember, practice makes perfect, and when you are playing a game that is as difficult and complicating as 1031 exchanges, you need a lot of practice before you get perfect.
Post a Comment