1031 Exchange, Is it worth it?

Question

I currently have a rental property for sale. I spoke to my accountant about doing a 1031 exchange. His advice was pretty simple. I can pay the known tax rate of 15% today or hope that the tax rate doesn't increase and pay the taxes somewhere down the line. I compare this to a Traditional IRA vs. a Roth IRA. My accountant advised that I pay the taxes now and skip the 1031 exchange because taxes will most likely be higher in the future and will almost certainly not be lower. Looking for other opinions on this.

Dave Foster · Answer

@Chris Thompson, Some peoples Kids!!   Ask that accountant if he has a retirement account - an IRA or a 401K.  He must be planning on liquidating it soon so he can pay today's tax instead of the tax in the scary future.

If your gain doesn't justify the cost.  If you can't find new replacement real estate.  If you want to stop investing in real estate.  If you need to pay for a new kidney....These are legitimate reasons to sell and pay the tax.

Tell him to stick to filing out 1040s.  He's not much of a financial advisor!

Guifre Mora · Answer

Fire your accountant. Is his job to save you money on taxes not MAKE you pay taxes?

Did he mention there is a depreciation recapture? These add up over time, and all of the cumulative depreciation deductions you’ve taken are considered taxable income once you sell. Does 25% tax in your tax bill sound good to you?

Chris Thompson · Answer

Thanks for the input but you can keep the rude and condescending comments. I understand deferring the taxes forever from an estate planning perspective but that isn't my plan. I will eventually sell these properties and will have to pay all of those deferred taxes. Do I pay now or pay later? What are the advantages of paying later?

Lauren Speidel · Answer

@Chris Thompson The biggest benefit of the 1031 Exchange is the estate planning! Which means if you keep exchanging into larger and more profitable properties you should have (hopefully) a steady stream of income. Eventually when you pass away your beneficiaries receive a step up in basis which means they aren't responsible for the tax liability that you've deferred over your lifetime.

And I agree with @Dave Foster, if it doesn't financially make sense for you to do a 1031, you don't want to continue to own real estate or you're not finding good deals out there, definitely reasons to not engage in an Exchange.

Jaysen Medhurst · Answer

That's a lot of speculation on the part of your CPA, @Chris Thompson, and honestly sounds like someone w/o too much REI exposure. He doesn't know any more then anyone else if or when taxes rates will change. It also ignores the ability to "swap 'till you drop" and defer those CG taxes indefinitely.

I think it really depends on the size of the deal and if deferring those taxes is worth the cost and potential stress of a 1031 exchange. @Dave Foster, do you have an over-under where you think a 1031 is or isn't worth it?

Alyssa Dyer · Answer

@Chris Thompson curious to see what you decide!

Dave Foster · Answer

@Chris Thompson, Sorry I got caught in a moment. But my comment wasn't directed at you at all.  Your's is a common question I'm asked all the time and unfortunately I still hear the tax now vs later answer too often. I gave a flippant answer to them not you.  .But I didn't need to ;)

Compound interest isn't an all or nothing game.  Every day you keep money in your pocket is a day you make the money off of that money.  Every time money leaves your pocket it stops making money for you.

The question for you really is "should you stay investing in real estate or not?"  If so then it would certainly seem that doing a 1031 is the prudent course because of the nature of compound interest.  If you're not continuing investing in real estate then paying the tax now is your only option unless you take advantage of @Michael Belmores suggestion of owner financing.  Or use an exotic thing like a charitable remainder trust.  But that actually does still leave you in the real estate investing game - just as a financier instead of a landlord.

Simply asking whether you should should pay the taxes now or later will always get the same response from me - later!  This is why I have both a traditional and Roth IRA and an S401K.  And it's why I do 1031s for myself.  And I've had those retirement accounts through many years of up and down taxes.  Yet still I keep them - why?  Because every day a dollar earns money for me is better than a day it doesn't.

Michael Belmore · Answer

Hey Chris,

One option could be when you eventually sell the properties you can do so using seller financing in which you hold the note. That way you can capture interest, avoid taxes, and have steady income into retirement.

Good luck out there!

- Mike

1031 Exchange, Is it worth it?

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