Investopedia says the average 20-year returns in the commercial real estate slightly outperform the S&P 500 Index, running at around 9.5%. Residential and diversified real estate investments do a bit better, averaging 10.6%. Real estate investment trusts (REITS) perform best, with an average annual return of 11.8%. Many people who traditionally invested in real estate often do not trust – or bother to understand the stock market, while most people who invest in stocks are uncomfortable with real estate. What are the benefits of real estate? Let’s start with the 1031 Exchange.
What are 1031 Exchanges?
According to current law, a taxable transaction generally includes a sale or exchange of property. If you sell a business or farm, you will owe taxes on the gain from your basis (your cost). 1031 exchanges are a special rule that provides you do not recognize gains or losses if you exchange property for like-kind property. “Like-kind is pretty broad. Currently, you can continue exchanging one property for another and not pay any capital gain taxes.
1031 exchanges do not apply, however, to exchanges of stock in trade or other property held primarily for sale. Those would include stocks, bonds, partnership interests, certificates of trust or beneficial interest, other securities, etc. They do not apply to your primary residence.
A like-kind exchange does not require that the exchange of properties happen simultaneously. As long as you identify the property received in the exchange within 45 days and ultimately received within 180 days of the sale of the original property, then gain is deferred.
7 Key Rules About 1031 Exchanges
Robert Wood writing in Forbes about 7 Key Rules About 1031 Exchanges says, “There’s no limit on how many times you can do a 1031 exchange. You can roll over the gain from one piece of investment real estate to another, then another and another. You may have a profit on each swap, but you avoid tax until you actually sell for cash.” But, he cautions, be careful and do it right. Doing it right means to Wood::
- Investment, Not Personal. Use a 1031 Exchange only for investment and business property, not personal holdings like your house.
- Like-kind is Broad.
- Delayed Exchanges are OK.
- Designating Replacement Property. There are two timing rules you must observe for a delayed exchange.
- Close Within Six Months.
- Cash Taxed. Cash left over? The intermediary pays it to you at the end of the 180 days. That cash or “boot” gets taxed, generally as a capital gain.
- Beware Mortgages. Be sure to consider mortgage loans or other debt on the property you relinquish, and any debt on the like-kind replacement property you acquire. If you don’t receive cash back, but your liability goes down, that too will be treated as income just like cash.
Could 1031 Exchange Elimination be on the table?
I suspect as the government seeks every means for additional taxes to run the government, 1031 exchanges will get repealed, or some way will be found to end the rollover ad infinitum. While the1031 exchange lasts, enjoy the benefit of real estate.
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