If you are an investor in real estate business planning to buy and sell a lot of properties to earn dividends from this booming sector, you must have already heard about ‘property exchange’. You may have already ‘exchanged’ properties. In case you are a newbie in the real estate business or somehow in need of selling your real estate investment property, you need to know what property exchange is all about. Here is a simple instance to make it easier to understand:
Say, you bought your home at a cost of $300,000 two years back. Within this time your property value has appreciated by $50,000. Now, you plan to sell your home either for job relocation or for making a timely profit. If you directly sell your home to a buyer, you shall be considered to have a capital gain of $50,000 which will involve a levying a Capital Gains Tax to the Government exchequer. This will significantly reduce the sales profit you desired to achieve. Instead, if you undertake a ‘property exchange’ (which literally means exchanging your property with a ‘like-kind’ property), payment of your Capital Gains Tax can be deferred to a future date. This will allow you sufficient time to realize the profit from the property now and pay the tax later when it becomes easier. In the U.S., this type of transaction has been authorized by IRS (Internal Revenue Service) Code’s Section 1031 hence real estate property exchange of this kind is popularly known as a ‘1031 exchange’.
1031 exchange has been found to be an effective real estate asset protection strategy. Through this property exchange, a real estate investor can reinvest full equity from a property sale into the buying of a like-kind property evading capital gain recognition. At the end of transfer/exchange both the seller and buyer benefit immensely from the transaction.
Due to inherent advantages, property exchange is becoming increasingly popular amongst the real estate businessmen. A personal residence, however, does not qualify for such exchange. The striking advantages of a property exchange or a 1031 exchange in particular are:
o Capital Gains Tax is deferred to the advantage of the exchanger.
o Equipment having a fair market value of 15% of the main real estate property can be included with the exchange without recognizing a capital gain.
o It allows you to have a better leverage thus improving cash flow.
o 1031 exchange is mostly done with a three-party delayed process with the involvement of a financial intermediary or accommodator. This ensures safe and reciprocal exchange of funds.
o You can achieve diversification and improvement of your real estate portfolio with the cash saved from the tax deferment.
Although profitable, property exchange involves a complicated process. Detailed knowledge of the system is a pre-requisite for a successful exchange. However lucrative, you must consult a reputed realtor before you embark on a property exchange venture.