How A 1031 Exchange Can Expand Your Real Estate Portfolio

Whether you're dealing with a life change or just a change in real estate investment strategy, the IRS's 1031 exchange option offers you the opportunity to defer capital gains taxes.

Seasoned real estate investors probably have taken advantage of the 1031 exchange many times. However, newer investors may not understand all the advantages a 1031 exchange can provide to their investment portfolio.

What Is a 1031 Exchange?

The IRS explains and has long recognized like-kind exchanges. You do not have to pay capital gains under Section 1031 of the tax code as long as you continue to hold your investment in the like-kind property.

Under the Tax Cuts and Jobs Act passed by Congress in 2017, 1031 exchanges were limited to real property. Like-kind properties are not so severely restricted. If you sell a residential property, you are not required to invest in another residential property. You can sell an apartment building and invest in a commercial property, such as a self-storage facility.

Through a delayed 1031 exchange,  the IRS also gives you the opportunity to sell one piece of property then reinvest in another like-kind property within a certain period of time. Typically, you must act on the new acquisition within 45 days of completing the sale, and you have 180 days to complete the transaction.

Options for 1031 Exchange

Options for how you could take advantage of a 1031 exchange will vary depending upon your situation and your investment strategy, but here are a few scenarios that might inspire ideas for your situation:

  • You are divorcing or dissolving a business partnership and need to split the assets of a commercial building. You sell the property, split the assets and reinvest your portion in another real estate holding within the 45-day window, deferring your portion of the capital gain.
  • You have owned and managed a 20-unit apartment building for 25 years, and are now ready to retire and slow down. You sell the property and reinvest in less-stressful type of property, such as self-storage units that require less hands-on management. You also could invest the money into a real estate investment trust (REIT) or another type of crowd sourced real estate investment where another party manages the properties and you are now a passive investor.
  • You are an up-and-coming real estate investor who owns a 4-plex as well on a 10-unit residential apartment building, and you're ready to upgrade to a 25-unit apartment building. First, you need to make sure you've held both properties for at least 12 months, or the profit from a sale is taxed as regular income rather than a capital gain. This could be a situation where you need to take advantage of the reverse 1031 exchange option to buy the new property, then market your existing holdings.

Maybe none of these scenarios apply directly to you, but they can at least get you thinking about the strategy behind your real estate investments. One of the more stable options for real estate investing is self-storage units and have remained one of the safest real estate investments over the past 50 years. Since 2012, self-storage has seen 7.7 percent annual growth, according to statistics from IBISWorld.

To learn more about how an investment in self-storage real estate could be a solid performer for your investment portfolio and how a 1031 exchange can benefit you, feel free to contact us.