#208 1031 Exchanges: What They Are and Why You Should Consider Them

Hey, everyone, Hope you've had another great week and weekend. Wherever you're listening to this, whether you're in your car, you're between cases, you're walking your dog, whatever it might be, just congratulate yourself because it takes a lot to take action in today's world. We're distracted by so many different things, but you're taking the time to listen to this podcast to educate yourself, set yourself for the future. And so I just want to really honor your you right now. Any case, I just paid a pretty big hefty tax bill. Now, usually a good tax bill is because you made a good amount. And so I don't want to complain on that side. However, it always seems painful when we have to pay a certain amount in taxes. Now, I will tell you, it would have been much worse if I hadn't been investing in real estate, taking advantage of a lot of these tax breaks that happen to real estate and entrepreneurship. And even though I don't love talking about taxes, I do love talking about strategies to help keep more money in your pocket. So, having gone through the process, we've talked about different strategies to avoid taxes, but I want to focus for the next two weeks on a strategy that's really, really powerful when it comes to real estate, and that is the 1031 exchange. I'm going to talk about what it is and why you should consider these exchanges and what you need to think about when you go ahead and start planning for it. So stay tuned. Welcome to the Passive Income MD Podcast, where we talk about creating your ideal life through multiple streams of income. If you enjoy hearing about this stuff, make sure to hit subscribe. Now, let's get on with the show. Okay, just like I start any other tax talk, I'm not a tax professional. I just utilize the strategies that I learned from my tax professionals and other people in this space. But for your own particular situation, make sure you consult with your cpa, whoever that might be, to see whether these strategies are relevant for you. All right, so I just paid my extension, my estimate right now. And so I'm always thinking whenever I pay this amount, how could I do better next time? How can I do better next tax season? How can I be better organized? And what are the strategies can I use to keep more of my income in my pocket? Because we all know it's not easy to make money. I mean, in the sense that it takes work, strategy, investments, and if we could just tweak a few of those strategies to keep more at the end of the day, Then it doesn't actually take any more time out of your life to make that happen. So for many people who have been investing in real estate for a little while, maybe you own your own properties, you probably found that you have a good amount of equity in that property, meaning that over time the value of that property has gone up. You've been paying off the mortgage, really, your tenants have been paying off the mortgage. And so you've been thinking about what is next. Is this a property that I want to keep? Or maybe you want to move into a different property. Now, I had a friend recently go ahead and sell a few of his properties that were in Texas. He had bought them about five years ago. They had gone up in value and, and he wanted the cash and he went to cash out and he went and sold it on the open market, got that money. What he was surprised about was the amount of taxes he had to pay on the other side. Now, these are capital gains taxes, but when you make hundreds of thousands of dollars on a real estate transaction, you're going to pay a significant amount of taxes. And he came to me after the fact and asked me what could I have done to avoid paying more taxes. And I asked him if he had considered something called a 1031 exchange. So I want to talk about what that is today, how it might relate to your real estate investments, and again, how do you use that to keep more money in your pocket? So what is a 1031 exchange and how does it work? It's simply a tax deferral strategy. It allows real estate investors to. You swap one investment property for another without paying capital gains taxes on the sale. Basically, you kick the tax can down the road. Now, people wonder if this thing is legit. It's totally legit. And it's a provision in the US tax code named after Section 2, 1031. Now, there are multiple ways this exchange can occur. Today we're going to talk about the most common type, which is the delayed 1031 exchange. However, there are other lesser known strategies that we're going to save for next week's podcast. But for today, the major one that people use is this concept of the delayed 1031 exchange. It's where you sell your property and then you have 45 days to find a replacement property and 180 days to, to close. So what's nice about this is that you can go ahead and sell your property and there's some time to find that replacement. Now, there's some rules behind this type of replacement. It needs to be a like kind property. Now for those of you who don't know what that means, that means basically just two real estate assets of a similar nature, maybe of greater quality. And it can be exchanged so you don't have that tax liability, it can't be a primary residence. And it has to be a property that is essentially used for, for investment, trade or business purposes. And for all of us it's gotta be within the United States. So you can't transfer from United States to another country. Just to make it a little bit more clear, you could be trading a multi family for land from land to industrial, industrial to office space. And actually lesser known fact, again, talk to your cpa. Sometimes you can actually exchange into mineral rights that like we talked about in the past, it's actually a little bit looser than you think. You gotta talk to your CPA and the different tax professionals that these 1031 exchange experts that we're going to be talking about in a moment to figure out what actually constitutes a like kind property. But it's a lot looser than actually I had originally thought. Now just to clarify, the replacement property must be equal to or greater in value than the original property than the exchange funds. Then it allows you to defer that capital gains. Now just to clarify, there's no limit on the number of exchanges you can do. You can kind of keep exchanging from property to property to property. And many people use this as a strategy to keep kicking the tax can down the road so they're able to get a different property. Maybe they take the equity from one property, buy a better property that's better performing a larger property. And that's why you hear of people trading when they start with a, maybe a single family home investment, they exchange it to a duplex and they exchange it to some multifamily, then larger multifamily. And they just keep exchanging down the road as those properties improve. So yeah, why do people actually do it? If their property is performing exactly how they want, there's no reason to exchange or even sell the property. It's when their new property oftentimes has a better return on investment or better potential than the property you have. You can also consolidate multiple real estate properties using this exchange. Also, you've probably used some depreciation in the past. You can actually reset depreciation, take on new depreciation by getting a new property. We've talked about depreciation in the past and a way to that the IRS allows you to write off a lot of the value of the property as paper losses. We've talked about it some in the past. It's also a way to turn your vacation home, maybe into rental property, or you can sell one property to invest in several properties. So there's a lot of flexibility when it comes to this 1031 exchange. But to me, the most powerful reason to do it is to keep exchanging new properties and not have to pay capital gains taxes. Now, one of the greatest benefits for, for a lot of people I know, you're doing your investments, you're thinking about all of this, and you want to pass it along to your family, your heirs. And you think, I want to build generational wealth. Well, this is one way that people do build generational wealth, because what happens is if you continue to exchange and you never pay capital gains, when you pass on, you give that to your family, to your heirs, and what happens to them is they take on that property at what's called a stepped up basis or stepped up value, meaning it's like they acquired the property at the current market value. They could just turn around and sell that property if they wanted to and not have to pay any gains on it. All that equity that you've built up over time in exchanging and exchanging, exchanging gets pretty much wiped out whenever that gets passed on to the next generation. So you've probably heard of people creating generational wealth through real estate. This is one really powerful vehicle that allows people to do that. Now, just so you know, when you do the 1031 exchange, you have to do it correctly. You've got to identify the property. You, you gotta know your timelines, you gotta make sure these values are correct. And you have to choose something called an intermediary. You have to find the right company to help you with that, because there's a way that the money needs to be passed along. All of these things need to be documented correctly for you to be able to not trigger any sort of taxes. And you don't want to do this the wrong way. You want to find the right intermediary who knows what they're doing. You want to ask people in your community who they've used. You want somebody that's reputable and been doing this for years and years and, and understand how to do this in the proper way and the proper documentation so that it doesn't cause any sort of triggers and has clean paperwork moving forward. All right, I hope you've enjoyed this primer on 1031 exchanges. Again, a very powerful technique that you may want to use sometime in your real estate. Investing career. In our next podcast, we're going to talk about some more advanced strategies behind 1031. Things that are just different from this delayed type 1031. I didn't even know they existed, but we'll talk about them in our next episode. So have another great week and let's talk again soon. Enjoy the show. Let me know by dropping a review in the podcast app yearly. Listening to us in and if you haven't already, make sure to hit subscribe. 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