1031 Exchanges – What to do? What to do
The biggest challenge for owners that have bought and held properties for 20+ years is what they will do with the huge capital gains they have accumulated and the associated tax liabilities upon sale. On the one hand, their investment has grown multi fold and done quite well over the years, yet on the other hand, the uncertainty that they experience from not knowing how and when to exit from their investment, and the best way to grow it for the future often cripples their decision of selling. I commonly hear this from my clients; ‘I would consider selling but I just don’t know what to buy as a replacement and don’t want to pay capital gains’ tax.’
As with every other investment, it is important to consider several aspects before making any decisions. From the onset, it is critical to understand that the property that was purchased was always intended as an investment. As with any other investment, you don’t realize the gains from the investment until you sell. So if the property was purchased for $200,000 twenty years ago and today it is worth $2MM, the gains are not obtained until you sell it.
Another important element is to separate your sentiments from the decision-making process. Oftentimes owners attach a sentimental value to a property they have held for such a long time. Consequentially, these sentiments can cloud the ability to make a prudent decision. If the initial goal was to buy an ‘investment property, then it makes the most sense to treat it as an investment and sell and/or reposition the asset to increase your returns. To separate emotions from the investment gives a landlord the best chance to make the right decision.
Our government’s current real estate tax laws, more specifically regarding 1031 exchanges, have allowed owners to grow their investments tax-deferred. 1031 exchanges give an investor the ability to maximize the growth of their investment using every dollar of their gains. It allows the investor to purchase properties that they wouldn’t be able to otherwise afford if they had to pay taxes on the gains. It is probably one of the most important tax laws that have continually fueled the real estate growth in America.
The question as an investor is how to use the 1031 exchange as a driver for the bigger growth of your real estate investment. How do you make the most advantage of the current laws? The answer is like everything else in life, it is not black or white, it depends on each individual’s situation. No two situations are the same. However, as investment property owners vary from age to demographics, they all share one thing in common; how to use 1031 as a means to accomplish their goals. If the initial motivation of the purchase was an investment, think of the 1031 exchange as a way to defer the capital gain taxes, and utilize all of the net proceeds from a sale to transfer into the next investment of choice. The challenge is to prioritize your goals based on your current circumstances to identify the next best investment opportunity.
For more information, you may reach us at john@cbi-commercial.com