The 1031 Tax Deferred Exchange - Important Strategies for Real Estate Property Investors

California: As an investor in real estate you understand how important it is to preserve your wealth and assets. In the frequently changing world of taxation, you are fortunate to have IRC Section 1031. This tax code allows you to exchange from one investment property to another and defer taxes on the gain. This means that a 1031 exchange is a rollover of equity of like properties, rather than an avoidance of tax. Thus you continue to build wealth through real estate investment, and maintain your hard earned equity. Any tax liability through inheritance will be limited to gains from the date of the inheritor's acquisition, not during the years of ownership. So in essence the taxes that are saved now are never paid.
Basically since 1921, there has been an exception in the tax Code that Capital Gain Tax is deferred when investment property is "exchanged" as opposed to "sold." The policy behind Section 1031 is that Taxpayers should be able to dispose of investment or income property and acquire replacement investment or income property without incurring a large cost of sale-the Capital Gain Tax. This exception has changed very little since 1921.
These are some helpful tips and investment strategies using 1031 exchanges along with other 1031 "basics" that you should know about. The 1031 tax-deferred exchange is much more than selling a rental house and then buying another rental house. It requires a dedicated focus and guidance from a knowledgeable real estate professional. Today's sophisticated real estate investor can impact their portfolio dramatically by employing a variety of 1031 exchange techniques.
Why do a 1031 Exchange? No matter how nice your rental is, no matter how well built, if it's a 65-year-old home with three bedrooms and two full baths, its closets are probably too small and the kitchen is still decorated in the "I Love Lucy" era fashion. There's no great room, and no cathedral ceiling. In an era when people eat out or eat quickly, a great dining room has less appeal than in the past. Simply put, a lot of renters are interested in features not found in this type home.
On a personal level none of this bothers us. But in the contest for good renters -- folks who will be caring stewards of the property and pay their rent in full and on a timely basis -- newer properties seem consistently more attractive.
Those savvy about 1031s can start thinking creatively. For instance, one way to ensure that you see your college-attending child from time-time is to purchase a property in the college town and hold it as a rental, and do a 1031 exchange after graduation.
Getting tired of collecting rent and watching your residential investment property deteriorate from uncaring tenants? Are you afraid to sell after making such huge gains in the market? 1031 exchange will allow you to exchange a residential property for a business, or office rentals with a better paying clientele.
Exit Strategy: The lifecycle of a real estate investor tends to evolve to the point that one day; the investor would like to slow down, cash out, or retire. Whether the investor owns rental houses, warehouses, land, office buildings, or apartment complexes, a potential replacement property could be a well-located, residential property in a resort community in an attractive setting - such as a beach resort or mountain property.
To qualify for tax-deferred status, if those properties are purchased through a 1031 exchange transaction, they must be held for investment. To demonstrate the intent to hold for investment, most investors simply put those properties on a rental program with a management company or manage the property rentals themselves. However, at some point in the future, that same investor has the opportunity to employ a very powerful tool known as conversion.
Suppose several years after completing the 1031 exchange, the investor elects to move or retire full-time to the beach (or the mountains, lake, or golf community.) At the time the investor moves into the previously rented investment property, no tax obligations are due. The investor simply converts a property held for investment into his or her primary residence. The ultimate opportunity comes several years down the road, if and when the investor decides to sell the newly converted residence. At the time of that sale if the homeowner meets the residence requirements of ownership, occupies the property for at least two years, and held that previously 1031 exchanged property for at least five years, he will qualify for the $250,000 or $500,000 residential sale exclusion.
It is my hope that the information contained is helpful and should any one strategy or concept make your investments sounder, I would be glad to offer you any assistance at . You should consult your accountant before making a final decision on these or any investment proposals.

About the Author

Dennis M. Franklin, is affiliated with Family Realty Commercial Mortgage Company, a Licensed Broker, Ca. Department of Real Estate. If you would like to obtain more information regarding 1031 Tax Deferred Exchanges or commercial mortgage lending, please contact Mr. Franklin directly at (800) 642-2147, or visit us at

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