Most real estate investors are familiar with 1031 exchanges, which permit an investor to defer the payment of capital gain taxes upon the sale of qualifying investment property so long as they acquire like-kind replacement investment property. Many investors only consider the tax reasons for a like-kind exchange. That is, the deferral of taxes and the ability to fully reinvest the equity into the new investment property. However, there are many additional reasons an investor might want to exchange one property for another. Because of the broad definition of what is like-kind real property, investors are given considerable flexibility in changing the type or location of their real estate investment. The following are some typical non-tax motives to exchange:
· Exchange from fully depreciated property to a higher value property that can be depreciated.
· Exchange from a stagnant or slowly appreciating property to a property in an area with greater appreciation potential, i.e. reposition their assets.
· Exchange from non-income producing vacant land to improved property to create a positive cash flow from the rental income.
· Exchange from a property with maximized or minimal cash flow to a higher cash flow property to generate a larger cash flow.
· Exchange for a property or properties that may be easier to sell in the coming years.
· Exchange to meet location requirements. For example, a person moves to another state and wants to have their investment property nearby for management purposes.
· Exchange to fit the lifestyle of a person. For example, a retiree may exchange for a property requiring reduced management responsibility so they can do more traveling.
· Exchange from several smaller properties to one larger property to consolidate the benefits of ownership and reduce management responsibilities.
· Exchange from a larger property to several smaller properties in the same or different localities to diversify investment and possibly reduce risk. Exchanges can also be used to divide an estate among several children.
· Exchange to a property the client can use in his or her own profession. For example, a doctor may exchange from a rental house to a medical building or office condominium to use for his or her practice.
· Exchange from a partial interest in one property to a fee interest in another property.
· Exchange from a management intensive fee interest in real estate to a professionally managed triple net leased property.
· Exchange from an older property in need of repairs and/or system replacements to a newer property with more efficient and/or reliable systems.
· Exchange from one property owned free and clear to two or more properties with loans using leverage to acquire more investment properties and thereby increase income and/or appreciation potential.
This is not an all-inclusive list. The potential beneficial (and legal) uses for §1031 exchanges are often limited only by the imagination of investors and their advisors. As with any tax or estate planning, it should be done only after consulting with a tax and/or legal advisor to ensure the investor’s goals will be achieved by the §1031 exchange. An exchange can and should be just another tool of the intelligent real estate investor to acquire and preserve wealth.