For rental property management professionals and real estate investors, the fact that 44.1 million American households are renters is great news.
Many real estate investors buy properties with the intent of renting them out. While they might appreciate the opportunity to make money as an investor, they don't necessarily wish to handle the day-to-day management.
But investors appreciate the opportunity of handing off management to the properties while they continue to build their rental portfolio.
Another way investors work to build and grow the value of their property ownership is by taking advantage of the 1031 exchange rules.
Wondering about 1031 exchanges and how they're advantageous to real estate investors? Read on to learn more.
1. What Is a 1031 Exchange?
When you're managing rental properties, one of your goals might be to make it easy for your real estate investors to continue to grow their portfolios. Savvy real estate investors are working to improve the value and quality of their investments by taking advantage of the 1031 exchange laws.
These laws, which get their name from the Internal Revenue Code (IRC) Section 1031, are used when you sell one property and use the assets to buy another.
One of the key incentives to participating in a 1031 exchange is that you can avoid paying the capital gains taxes on the profits from the sale of the initial property.
2. Like-Kind for Investment Property
1031 exchanges are often referred to as like-kind exchanges. This means that the property you buy to replace the property you sold needs to have the same nature or character, even if they differ in grade or quality.
It doesn't mean you have to sell one duplex for another. It's not that specific to rental properties.
The 1031 exchange rules have tightened up since 2018's Tax Cuts and Jobs Act (TCJA). Now a 1031 exchange can happen only for a property.
Basically, like-kind means you can exchange one property for another. But since the rules have tightened to property, all of the exchanges that qualify are now considered like-kind.
This means you could sell vacant land and buy a commercial building. You could sell a single-family home and buy an apartment building.
3. 1031 Exchange Terminology
1031 exchanges come with some very strict rules. You want to have a tax attorney or a real estate lawyer involved if you hope to participate in one.
Making any small mistake and not following the rules could disqualify the 1031 exchange, meaning you'd need to pay the capital gains taxes.
Capital gains is the amount the property grows in value when it's sold. Taxpayers are expected to pay taxes on capital gains. But the 1031 exchange allows them to defer those taxes.
A key to the capital gains you can delay is the depreciation of the property, which is part of the 1031 exchange rules.
When you sell one property with the intent of participating in a 1031 exchange, you don't take the assets. They must be placed with a qualified intermediary.
The qualified intermediary is responsible for holding the money until the new sale is complete and transferring the funds to the seller of the second property.
If you hope to participate in a 1031 exchange, there are a number of rules you must learn, including:
- The three-property rule
- 200% rule
- 95% rule
- 45 days rule
- 180-day rule
To complete a 1031 exchange and avoid paying capital gains, the rules must be strictly followed.
Rental Property Management and Using a 1031 Exchange
Property management companies appreciate the opportunities for investors to stay in the real estate game by avoiding paying those capital gains taxes.
If you have investment properties, you may also need rental property management and we can help. Learn more about our management services and contact us today.