1031 Exchange: A Ladder To Wealth

Everyone wants a good get-rich-quick scheme. Minimal investment, maximum return, and you are practically on your way to a second home in the tropics. While that fast path to the luxe life is generally too good to be true, for real estate investors looking to build their wealth over time, the 1031 tax exchange is an option they should explore.

What is a 1031 Exchange?

Receiving its name from Internal Revenue Code (IRC) Section 1031, the 1031 Exchange is a swap of one investment property for another “like-kind” property, which enables the investor to defer paying capital gains taxes from the sale.

There are very strict requirements and timelines that must be adhered to, but there is no limit to the number of times an investor can participate in a 1031 exchange, and there is no cap on the capital gains tax that can be deferred, so profits can continue to be invested from one property to another to another indefinitely.

In other words, if planned and executed correctly, a real estate investor can legally avoid paying capital gains taxes as they climb the increasingly-valuable-property-owning ladder.

Using a 1031 as a Wealth-Building Strategy

The 1031 exchange gives real estate investors the ability to build their wealth as they reinvest their capital gains taxes into properties over the course of their lifetime. It is a slow, but steady course of action, which could work like this:

Step 1: You invest $30,000 into a turnkey rental in an affordable real estate market. With minimal updates, you rent the property to tenants and can start earning money immediately.

Step 2: Your property has increased in value, so you decide to sell property #1, and to use that money to invest in a bigger property to rent out. To take advantage of the 1031 exchange, you work with a qualified intermediary to properly identify and purchase like-kind property #2, rolling profits into this higher value investment without needing to set aside any cash for capital gains tax obligations.

Step 3: A few years later, property #2 is worth more than you initially paid, so you place it on the market and complete another 1031 exchange to purchase an even better investment property using the profits from the sale of property #2.

Since there is no limit to the amount of 1031 exchanges a real estate investor can complete, you can continue selling and purchasing increasingly higher-valued properties throughout your lifetime, without having to use any of the profits towards payment of capital gains taxes.

Though not a quick process, what started as a small amount of money could turn into a real estate portfolio worth millions (not even counting the continual cashflow from the rental properties), AND this wealth can be passed to your heirs, who may pay very little (or no!) taxes because they are not realizing gains when selling at current fair market value.

Using a 1031 exchange is a lucrative wealth-building strategy for real estate investors with a bit of patience. But to be truly successful, it is crucial that they work with a qualified intermediary and tax professional to ensure the timelines and requirements are closely adhered to, as missing a step can be incredibly costly for now… and for later.

Southern California Exchange Services has years of experience helping clients strategize and optimize their real estate investments through 1031 Tax Deferred Exchanges nationwide. We are committed to helping our clients pursue and realize their financial goals and are ready to help you, too. If you have any questions about the 1031 Tax Exchange, or are ready to take the first step, please visit our website or reach out to us at megan@sces1031.com or 805-738-2599. We look forward to hearing from you!