There are many potential benefits of doing a 1031 exchange of your property. In this article, we will explain some of these benefits, and how you can take advantage of them.
Defer Your Taxes
The first benefit of a 1031 exchange is that you get to defer the recognition of these gains and not have to unnecessarily pay taxes prematurely. What’s the benefit of keeping that money working for you?
Well, if you don’t have to recognize the gains on the sale of your farm, you can take the money that would have otherwise gone to the government in taxes, and reinvest it into new replacement property and continue to grow your wealth. It also means that you have that much more money to redeploy and lever up.
Levering Up
Another advantage of a 1031 exchange is the ability to lever up. Levering up means you can buy a more expensive replacement property because you have more as a down payment. The advantage of levering up is that rather than having one small boat in the harbor, you can have a yacht or a tugboat. And when the tides roll in and appreciation occurs, you’ve got a much bigger asset appreciating in value.
Right now, interest rates are low and debt or capital is very available. By levering up we can acquire a bigger asset. So rather than exchanging into a small property, you can exchange into a bigger property and that means you’ll have more basis to depreciate in the future. Normally in a 1031, if you lateral (or exchange into a property of equal value), you’re not going to have any more basis to depreciate than you otherwise would have. By using leverage and exchanging into a property that’s more valuable, you’re going to have more basis to depreciate. Keep in mind that this is only applicable if you’re buying properties with improvements and not raw land. Nevertheless the concept is: buy up in value, compound and grow your wealth, and take advantage of tax deductions for the theoretical wear and tear or depreciation of your property.
About the Author:
Jeffrey Peterson is the president of Commercial Partners Exchange Company, LLC. He received both his B.A. and his J.D. from the University of Minnesota, and is a member of the Minnesota State Bar Association and the Tax Section of the American Bar Association. He is also a former adjunct tax law professor at William Mitchell College of Law and instructor for Kaplan Real Estate Education.