Equity is back for many investors! That means it’s time to start thinking about equity optimization strategies again.
Ahhh….it reminds us of the good old days before the mortgage meltdown.
But until liberal lending comes back (yes, it eventually will…), a 1031 tax deferred exchange is a very useful tool for moving passive equity (the unrealized capital gains) from a particular property to another market or property (or multiple markets and properties!) that you think can perform better. Or maybe you just want to diversify.
So to discover the latest and greatest in 1031 exchanges, we called up an old friend and invited ourselves out for lunch. Our friend was delayed in a meeting, so we had lunch without him. When we were finished, we sat our friend down in front of our mobile microphones and picked our teeth and his brain.
In sunny San Jose, California recording this interesting exchange of ideas:
- Your talented today host, Robert Helms
- His talent-deferred co-host, Russell Gray
- Special guest, 1031 tax-deferred exchange expert, Ron Ricard
If you’re old enough and were bright enough to buy investment real estate a long time ago, you probably have some equity in your properties. Some of it is the original purchase equity (down payment), and another big chunk of it is from amortized equity (pay down of the loan using the rental income), and (hopefully!) the BIGGEST chunk is from passive equity (long term price appreciation). For that matter, you might even have a chunk of forced equity (appreciation directly tied to work you did to increase the value).
Or maybe, you were bold enough to buy property in the pit of the recession and now you’re the happy holder of gobs of new equity in a short period of time. Good job.
In any case, if you have equity above and beyond your adjusted cost basis, you have capital gains. And as long as those gains stay locked up in the property, you have unrealized capital gains. That doesn’t mean you don’t know the equity is there. 😉 It means you haven’t gone from cash to asset and back to cash again. In other words, you haven’t sold the property and realized the gains.
Whew. That was taxing…
But what do you do if the market or property you’re in is no longer the BEST place for your equity?
One option is to refinance the property and take some of the equity out with a cash-out loan. Great idea, except those loans are hard to come by these days. And that strategy only works if you still want to be in that property or market.
But what if you want to shepherd your equity to greener pastures?
If you simply sell the property, you’re off the hook for your loan (this might be important if it’s a residential 1-4 unit property and the loan counts against your Fannie / Freddie limit), and you have access to the equity…or do you?
Remember, you have a BIG FAT PROFIT. Which is awesome, except when you file your tax returns and Uncle Sam says, “Hey! Where’s MY cut?
And Uncle Sam’s cut can be pretty hefty in terms of absolute dollars. Think about it. If you have a $100,000 gain, your tax might be as high as $25,000!!! That could be a down payment on a nice little rental property in Memphis, Atlanta or any number of low price, high cash flow markets. Ouch.
That’s why a 1031 tax deferred exchange is a cool deal.
Simply stated, section 1031 of the IRS code (hence the name) provides an alternative to tax today IF you transfer your equity DIRECTLY (you can’t touch it in transit) into one or more other investment properties. The tax is DEFERRED until such time as you actually realize it. If you plan it right, you’ll NEVER realize it, but will still have access to all the money. Of course, that’s the topic of another show….
For now, what you need to know is to get this WONDERFUL benefit, you MUST follow the rules.
Yes, there is a catch. There are rules. Like the 3 property rule, the 45 day identification rule and the 180 day rule. Just to name a few…
But we’re not going to clog our blog with all the nitty gritty details. First, we’re not tax guys and we’d feel really badly if you read this blog and make an important tax decision and that doesn’t work out. Next, it’s WAY too much detail for a blog. And lastly, you should ALWAYS consult with a qualified tax advisor when planning moves which have important tax implications. Don’t be penny-wide and pound stupid.
The purpose of this blog and episode of The Real Estate Guys™ radio show is to make you aware that the 1031 tax deferred exchange exists…and is an important and powerful tool for repositioning and optimizing equity. We also want to encourage you to get qualified advisors involved WAY in advance of making any decisions. Yes, it’s a hassle and an expense. But so is writing a HUGE check to the IRS.
The bottom line is NOW is the time to start getting educated about your equity optimization strategies and tools.
So listen in to this episode and our guest Ron Ricard will give you a great primer on 1031 tax deferred exchanges.
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