1031 Exchange - Why Bother You'll have to pay taxes eventually right? - Biggest Myth
Member since 2024 · 25 posts · 30 votes
1031 Exchange - Why Bother You'll have to pay taxes eventually right? - Biggest Myth
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Mechanicsburg, PA · Member since 2013 · 3k+ posts · 2k+ votes
2yI have done many 1031s over many years, there are a couple or three points that I would like to include:
1. The time frames of 45 days for identification of replacement(s) and the 180 days to close are hard and fast. And I've seen people say the later is 6 months, not true because some 6 month periods have more than 180 days. You have to follow all the IRS rules or leave yourself open to disallowing.
2. The time flies by when you are under the time requirements. Often times you're selling a good deal but can't find a replacement that is as good as the property you're relinquishing. I've seen deals where investors accept a deal that's not so hot just to comply with the time frames. One of the things we do to circumvent this problem is to start earlier. The clock starts when you settle on the first property, but you can start looking for a replacement before you settle and before the clock starts. You can even start looking for the replacement before you decide to sell the relinquished property.
3. And as I talked about in Bigger Pockets Podcast #82, imho capital gains tax should be indexed to inflation. Particularly if you owned the property for a long time, much of the capital gain is due to inflation and should not be taxes.
David Krulac
Bigger Pockets Podcast #82
13 Replies
- 2yJake AndronicoBusiness MemberRealtor · Reno, NV · Member since 2019 · 1k+ posts · 938 votes
Yep, extremely powerful tool. Thank you for sharing.
- Mechanicsburg, PA · Member since 2013 · 3k+ posts · 2k+ votes2y
I have done many 1031s over many years, there are a couple or three points that I would like to include:
1. The time frames of 45 days for identification of replacement(s) and the 180 days to close are hard and fast. And I've seen people say the later is 6 months, not true because some 6 month periods have more than 180 days. You have to follow all the IRS rules or leave yourself open to disallowing.
2. The time flies by when you are under the time requirements. Often times you're selling a good deal but can't find a replacement that is as good as the property you're relinquishing. I've seen deals where investors accept a deal that's not so hot just to comply with the time frames. One of the things we do to circumvent this problem is to start earlier. The clock starts when you settle on the first property, but you can start looking for a replacement before you settle and before the clock starts. You can even start looking for the replacement before you decide to sell the relinquished property.
3. And as I talked about in Bigger Pockets Podcast #82, imho capital gains tax should be indexed to inflation. Particularly if you owned the property for a long time, much of the capital gain is due to inflation and should not be taxes.
David Krulac
Bigger Pockets Podcast #82
- Member since 2024 · 2 posts · 2 votes2y
But what if I don’t want to pass anything on? Is there any way to avoid paying capital gains tax if I eventually sell? Otherwise the 1031 Exchange is worthless. It only makes sense if you plan to pass on real estate.
- 2yJay HinrichsBusiness MemberReal Estate Consultant · Summerlin, NV · Member since 2014 · 45k+ posts · 66k+ votes
Quote from @Daryn Dockter:
But what if I don’t want to pass anything on? Is there any way to avoid paying capital gains tax if I eventually sell? Otherwise the 1031 Exchange is worthless. It only makes sense if you plan to pass on real estate.
charitable remainder trust - 2yJay HinrichsBusiness MemberReal Estate Consultant · Summerlin, NV · Member since 2014 · 45k+ posts · 66k+ votes
Quote from @David Krulac:
I have done many 1031s over many years, there are a couple or three points that I would like to include:
1. The time frames of 45 days for identification of replacement(s) and the 180 days to close are hard and fast. And I've seen people say the later is 6 months, not true because some 6 month periods have more than 180 days. You have to follow all the IRS rules or leave yourself open to disallowing.
2. The time flies by when you are under the time requirements. Often times you're selling a good deal but can't find a replacement that is as good as the property you're relinquishing. I've seen deals where investors accept a deal that's not so hot just to comply with the time frames. One of the things we do to circumvent this problem is to start earlier. The clock starts when you settle on the first property, but you can start looking for a replacement before you settle and before the clock starts. You can even start looking for the replacement before you decide to sell the relinquished property.
3. And as I talked about in Bigger Pockets Podcast #82, imho capital gains tax should be indexed to inflation. Particularly if you owned the property for a long time, much of the capital gain is due to inflation and should not be taxes.
David Krulac
Bigger Pockets Podcast #82
yup U see this often made rush to close and settle for a not so great deal.. @Daryn Dockter it’s not worthless if you plan to buy another property at sale. If you do. You keep large amounts of cash in your hand to invest in the next property. Last year I did an exchange on a property I sold for $370k. I would have owed about $70k in taxes. I exchanged for a new $600k build and only needed a $230k loan instead of a $300k loan. Even at only 6% That lowered my payment $420/mo and will save me $80k in interest. For free. I was going to buy another property anyway.
Why would you ever sell? You can’t live off the rental income? You can take 80% tax free as a cash out refi, if you need a large chunk of “cash”. Are you saying if you’re so desperate you need the last 20%? If landlording becomes “too difficult” for you, buy different properties. I only have a dozen but that easily brings in $20k a month in net income and requires less than an hour a month worth of work with a PM. More than half of that is accounting, pay a bookkeeper $100/mo and you should be working less than 10 minutes per week.
If you don’t have anyone to leave anything to, then yes, you can find investing beyond “having enough” pointless. But if you do have someone, or find someone, or find a charity you believe in. You can leave them the house without paying taxes. That means the person or charity gets 25% more than if you sold and gave them the proceeds. Plus MAYBE you can light the spark that leads them to investing and financial independence. That’s what I’m using it for.
I’ll leave them a house they can rent out or sell. But if they sell 1/2 the proceeds go to the other heirs. If they all sell they all get 100% of the proceeds. But anyone that holds on gets the house and 4% of the cash of everyone that sold.
Nobody’s saying you have to use a 1031, but it is a large and powerful gift. Nearly as big a gift as section 121 exemption. Which may come in to play if your finally 1031 rental property turns out not to make a good rental but an ideal retirement home for yourself, eventually. Good luck and enjoy the journey.
- 2yJay HinrichsBusiness MemberReal Estate Consultant · Summerlin, NV · Member since 2014 · 45k+ posts · 66k+ votes
Quote from @Bill B.:
@Daryn Dockter it’s not worthless if you plan to buy another property at sale. If you do. You keep large amounts of cash in your hand to invest in the next property. Last year I did an exchange on a property I sold for $370k. I would have owed about $70k in taxes. I exchanged for a new $600k build and only needed a $230k loan instead of a $300k loan. Even at only 6% That lowered my payment $420/mo and will save me $80k in interest. For free. I was going to buy another property anyway.
Why would you ever sell? You can’t live off the rental income? You can take 80% tax free as a cash out refi, if you need a large chunk of “cash”. Are you saying if you’re so desperate you need the last 20%? If landlording becomes “too difficult” for you, buy different properties. I only have a dozen but that easily brings in $20k a month in net income and requires less than an hour a month worth of work with a PM. More than half of that is accounting, pay a bookkeeper $100/mo and you should be working less than 10 minutes per week.
If you don’t have anyone to leave anything to, then yes, you can find investing beyond “having enough” pointless. But if you do have someone, or find someone, or find a charity you believe in. You can leave them the house without paying taxes. That means the person or charity gets 25% more than if you sold and gave them the proceeds. Plus MAYBE you can light the spark that leads them to investing and financial independence. That’s what I’m using it for.
I’ll leave them a house they can rent out or sell. But if they sell 1/2 the proceeds go to the other heirs. If they all sell they all get 100% of the proceeds. But anyone that holds on gets the house and 4% of the cash of everyone that sold.
Nobody’s saying you have to use a 1031, but it is a large and powerful gift. Nearly as big a gift as section 121 exemption. Which may come in to play if your finally 1031 rental property turns out not to make a good rental but an ideal retirement home for yourself, eventually. Good luck and enjoy the journey.
this is why investors should try to achieve paid for real estate small number of grade b or A homes leads to the lifestyle pretty much everyone on BP wants.. no work and cash flow :) Good job Bill Thanks @Jay Hinrichs Your path looked way too hard. You’re the true definition of a real estate investor. I’m just a guy that didn’t want to work his whole life. Thanks again for the kind words.
- 2yJay HinrichsBusiness MemberReal Estate Consultant · Summerlin, NV · Member since 2014 · 45k+ posts · 66k+ votes
Quote from @Bill B.:
Thanks @Jay Hinrichs Your path looked way too hard. You’re the true definition of a real estate investor. I’m just a guy that didn’t want to work his whole life. Thanks again for the kind words.
U got that right its not been all wine and roses thats for sure.. :) But its something new everyday.. I am off to Montana to go flyfishing here in a minute so I do get some free time :) - Specialist · Grand Rapids, MI · Member since 2020 · 116 posts · 80 votes2y
Quote from @Daryn Dockter:
But what if I don’t want to pass anything on? Is there any way to avoid paying capital gains tax if I eventually sell? Otherwise the 1031 Exchange is worthless. It only makes sense if you plan to pass on real estate.
There are several strategies actually! A lot of this depends on your goals, but you can use a couple options.
If you're charitably inclined, CLATs (Charitable Lead Annuity Trust) or CRUTs (Charitable Remainder Unitrust). You could even look into Opportunity Zones.Other options are doing a Cost Segregation study depending on the property.
To drag out the gains, you can do a Deferred Sales Trust, or Installment Sale.
- Specialist · Grand Rapids, MI · Member since 2020 · 116 posts · 80 votes2y
Quote from @Jay Hinrichs:
Quote from @Daryn Dockter:
But what if I don’t want to pass anything on? Is there any way to avoid paying capital gains tax if I eventually sell? Otherwise the 1031 Exchange is worthless. It only makes sense if you plan to pass on real estate.
charitable remainder trustYeah a CRUT is good before you sell, and a CLAT (Charitable Lead Annuity Trust) is good for after you sell the property... obviously time is of the essence there!
@Daryn Dockter it is extremely powerful to defer taxes, whether it is 5 years, 10 years or more. That is a fact, and it’s called time value of money.
Let’s assume you can achieve 15% compound returns. And let’s say you defer paying $100k of capital gains (let’s ignore depreciation recapture for now). In 5 years your $100k of deferred taxes becomes $200k, and in 10 years that $100k becomes $400k. Even if you sold your 1031 upleg after 5 years, you pay the $100k of deferred taxes from your original sale, but now you’ve made an additional $100k profit. If you wait 10 yrs then you’ll have $300k profit. So instead of having $0, you now have $100k (or $300k) less tax. Obviously the gain increases significantly the longer you defer your tax payment.
So would you rather have $0 or would you rather have something greater than $0? The answer is obvious, thus it’s obvious to maximize tax deferral as long as you’re investing the money (and enjoying some of it as well).
- Mechanicsburg, PA · Member since 2013 · 3k+ posts · 2k+ votes2y
@Daryn Dockter if your profit is low it probably now worth it to do a 1031. There is a cost to doing an 1031, the Qualified Intemediate could charge say from say $500 to $2,000 or more. If your Capital Gain tax is less than a few throusands then its probably not worth doing a 1031. oth, if you have a large Capital Gain, it can make a lot of sence to do a 1031. For example we had a property that we bought at a great bargain price of $30,000; and sold it for $435,000, with a Capital Gain of over $400,000. Even at 20% Federal Capital Gains would be $80,000 plus any state and local taxes, and 25% Depreciation Recapture, if any. For me I'd spend the $2,000 to save $80,000 + even if I only kept the acquired property for a few years. As mentioned above one way to mitigate the tax bill when due would be to convert the acquired property to a personal residence and use as such for the next 2 of 5 years, and cancel out $500,000 of gains, if married.
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