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A 1031 tax-deferred exchange refers to a very important strategy for investors in maximizing cash flow while meeting IRS tax requirements. This is something every investor should be aware of and can benefit from as long as they're willing to jump through a few IRS "hoops." Section IRS 1031 of the tax code allows a person to defer, or put off, payment of the taxes on money they make on the sale of a piece of property. The only stipulation is that you have to buy a similar piece of property with that money. Sounds too good to be true? Well, in fact it's not. Any money made on a piece of real estate is normally taxable, and under IRS 1031 it still is, but you can wait to pay it if you purchase another, often upgraded, piece of real estate. So let's say you purchase an investment property for $180,000 and ten years later you are able to sell it for $230,000. Normally, your $50,000 profit would be subject to taxes. If however, you choose to use the money you receive to buy another piece of property, for example a multi-family home, you can put off paying the taxes until you sell the second piece (or pieces) of property. This creates extra cash flow for you. All you have to do is exchange properties that are "like-kind." You cannot use the money from your sale of real estate to buy your wife a diamond necklace, and yourself a brand new small yacht to put off paying your taxes. To make a 1031 tax-deferred exchange you've got to buy another piece of property or properties. So what kinds of properties are eligible for the exchange? Most properties, apartments, houses, buildings and other forms of real estate are able to be considered "like-kind" properties in exchange for one another. However, there are some specific stipulations that the IRS does enforce: 1) Inventory, or stock-in-trade are off limits, 2) Stocks, bonds, or notes are specifically prohibited from this tax deferment, 3) Other securities or debts are not allowable, and 4) Certificates of trust are also excluded. Moreover, you can actually exchange more than one piece of property for the original piece of property. You can buy any number of properties with the money made from the first sale, but only for up to two times the amount of the value of the original property. All told, the 1031 tax-deferred exchange is an excellent way to put off paying your taxes and free yourself up to continue investing in real estate, often more profitable real estate. It should be integrated into any real estate investment strategy.
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