At Muldoon Associates, we are often asked how 1031 Exchanges work and whether they make sense for the investors we work with.
Today, we’re going to answer those questions and dive into the 1031 Exchange. Maybe you are familiar with it and maybe you are not. What you really need to know is that it’s basically a way to defer your tax liability when exchanging real estate. It can be a valuable tool for investors.
Exchanging Real Estate with a 1031 Exchange
Let’s say you have an asset in Washington, D.C. and you want to buy an investment property in Colorado. You have equity in the property you currently own, so if you were to sell it, you would have to pay capital gains taxes on that property, including depreciation, appreciation, etc.
If you are planning to use the cash you earn to re-invest in real estate anyway, you can do that through a 1031 tax-deferred exchange. The process would work like this:
- First, you sell your current property in Washington, D.C.
- Then, you take the proceeds from that sale and apply it to the new purchase you want to make in Colorado.
- With the reinvestment of those proceeds, you will defer the payment of taxes until a later date.
Let’s be honest, you are never going to get out of taxes if you are running your businesses legitimately. But, you can defer those taxes almost indefinitely with the 1031 Exchange.
Exchanging Like Properties
It doesn’t have to be exact, but your current property and your new property have to be similar. The idea is to exchange like property for like property. Let’s say maybe you have an apartment complex and you want to buy a single-family home. Or, you own a single-family home and you want to buy an apartment complex. That’s allowed, as long as you’re using the assets as rentals.
You also want to consider how the value of your new property will compare to the value of your current property. If your value goes down and you take any proceeds from the benefit of the sale of your first property, you’ll be taxed at whatever your taxable rate is. Make sure you check the details with your CPA so you know what those numbers are. They will help you understand whether the 1031 Tax Exchange is something that is going to work in your specific situation.
Working with Professionals
The 1031 Tax Exchange is usually an excellent idea, but it can be complex. There are restrictions and regulations, and you must identify and close on the new property in a specific amount of time. There are companies that specialize in these transactions, and they can be helpful in helping investors navigate the process.
If you have any general questions about this tax-deferred exchange or if you’re looking for investment properties in Colorado Springs with the funds you’ll earn from a 1031 Tax Exchange, please reach out to us. We have worked with several of them and would be happy to help you as well.
Contact us at Muldoon Associates for additional information.