Broker Check

1031 Exchanges: What They Are and How They Work

| June 17, 2019

In our last series on real estate investing, we covered the basics, including how real estate offers unique income and estate tax opportunities.

But as we know, one of the potential downfalls of real estate investing is directly owning property, and thus being charged with maintenance, upkeep, management, administration and so on. That downside can be more punitive the longer property is held.

As long-term owners grow weary of these “holding pains,” they might consider selling the property for cash as a solution. Selling can also help alleviate succession or estate-related issues.

However, a sale can trigger a potentially significant tax liability and open you up to “depreciation recapture” that could also be pricey.

The point is, selling may not be the ideal solution.

So in this new series, we’d like to dive a bit deeper on a specific piece of real estate investing – 1031 exchanges – and how they can allow owners to experience benefits without the headaches of selling.

Don’t Sell, Exchange Instead

Named for the IRS code governing the transactions, 1031 exchanges allow investors to exchange “like-kind” investment properties. Such an exchange extends the benefits of direct ownership while also allowing for a near-term, tax-deferred sale.

Using 1031 exchanges also allows for the future inheritance of property at a “stepped up” basis. That means when a beneficiary receives the property, the value is assessed at the current market rate for tax purposes, not the original purchase price.

This benefit helps people receiving property minimize their capital gains tax liabilities. And since there are no limits on the number or frequency of 1031 exchanges, this strategy can keep taxes low while keeping valuable investment properties within your portfolio over time.

What “Like-Kind” Really Means

The term “like-kind” can be confusing because it seems to imply that a particular type of property must be exchanged with a similar type of property.

That’s not the case.

If you think this strategy could work for you, don’t let the terminology trip you up or give you pause.

The application of the term is quite broad. It really means an exchange of investment (i.e,. income-producing) properties.

Of course, within 1031 exchanges there are several options, details and variables to consider. We will cover these more in future posts.

Securities sold through CoreCap Investments, Inc., a registered broker-dealer and member FINRA/SIPC; advisory services offered by CoreCap Advisors, Inc., a registered investment advisor. Cornerstone Financial and CoreCap are separate and unaffiliated entities.