Entrust Learning Center > 3. Investment Options > The Real Estate Investor's Secret Weapon

The Real Estate Investor's Secret Weapon

A 1031 Exchange can help you keep your money and reinvest it so you can continue to grow your real estate portfolio.

By: Dave Owens, CPA, CES; Entrust Freedom, LLC

IRA Insights

Real estate investors have a unique tool in their arsenal that other types of investors do not. One of the oldest tax code sections is 1031. This secret weapon is called a 1031 exchange. It’s one of the few areas of the tax code where the U.S. Government allows taxpayers to sell an asset and not immediately pay the taxes. Even state taxes are deferred.

A 1031 Exchange is fairly simple. If you sell a piece of investment real estate, and you want to buy another piece of investment real estate of equal value, you can defer all taxes indefinitely (capital gains (15%), recapture tax (25%), and state income tax). The benefit is that by not having to pay those taxes, you can keep your money (instead of giving it to Uncle Sam) and smartly reinvest it for yourself to grow your real estate portfolio. A 1031 is a free financial tool that lets you keep 15-30% of taxes you would have had to pay. In the world of increasing taxes, 1031 is a viable alternative.

There are some guidelines that need to be followed, and I will break them down. First, what is investment real estate? Investment real estate is defined as property used in a trade or business. It could be the real estate you use to run your office, or it could be rental property. One of the flexible features of 1031 is that all real estate is exchangeable. This means that a home can be exchanged for a condo or a piece of land can be exchanged for a commercial property. The way I think of it is: Any property with a deed can be exchanged for another property with a deed. Another nice feature of the 1031 is that you can sell one property and purchase more than one replacement property, or vice versa.

There are three main rules that investors need to know about 1031 exchanges.  First, you must use a Qualified Intermediary (an Independent Middleman) to help facilitate your 1031 exchange. The QI, as they are called, will prepare the Exchange Agreement, Escrow your 1031 proceeds, and most importantly make the exchange go smoothly.  The QI must be hired prior to the closing of the relinquished property.

Secondly, the Exchangor (the person doing the exchange) has 45 days from the closing date of the relinquished property to identify the replacement property. Identification means to list (not go under contract) up to 3 properties of any value and send them to the QI.  Finally, the Exchangor has 180 days (from the date closing on the relinquished property), to close on one of those three identified replacement properties.

I don’t want to over simplify 1031.  Please consult your tax advisor in addition to your Qualified Intermediary to analyze your exchange and to be sure you are making the best tax decision. I do believe that if you want to keep your money invested in real estate, then 1031 is a tool you must consider. 

1031 can be a potent weapon for the smart real estate investor. If you plan your transactions, you can watch your real estate portfolio grow. There is nothing worse than having a client not consider 1031, or not have their real estate professional tell them about it, and the relinquished real estate closes, but the client changes their mind. After the relinquished property closes, it’s too late to do an exchange.

Dave Owens, CPA, CES is the managing Member of Entrust 1031 Exchange. Dave and his staff have successfully performed over 10,000 exchanges since 1997. Entrust has an arsenal of tax free strategies. Feel free to contact Dave for more information or questions at (239) 333-1031 or owens66@entrustfreedom.com.