There are many potential benefits for a property owner who successfully executes a 1031 exchange. Some of these include:
1. Tax Deferral (Immediate And Indefinite)
In a properly executed 1031 exchange, capital gain taxes are deferred and transferred to “replacement property”. Taxes are not due until the taxpayer sells the “replacement property” without utilizing a 1031 exchange. Since there is no limit to the number of exchanges a property owner can complete, it is possible to defer the payment of tax indefinitely.
The 1031 exchange is commonly referred to as a tax “deferred” exchange, implying that taxes are not eliminated, only deferred until the replacement property is later sold in a taxable transaction. However, it is possible to potentially eliminate capital gain taxes altogether on the sale of property by exchanging into and holding property until death. Under current tax law, heirs of a descendant’s property receive a “step-up” in basis of the property’s tax basis to its fair market value upon death. This “step-up” in basis could conceivably enable the heirs to inherit property and then sell the property for fair market value soon after the decedent’s death and pay little or no tax. Thus, by employing the 1031 exchange until death, it may be possible to not only defer taxes on the sale of property, but to permanently eliminate them.
2. Improvement In Cash Flow Return
A typical farm or ranch has a very low cash flow return based on the value of the property. By selling farm and ranch land and exchanging into other types of commercial real estate, you may be able to greatly increase your annual cash flow rate of return.
3. Consolidation Or Diversification
Families selling a farm or ranch have the ability to consolidate large tracts of land into one or more properties. As a risk reduction strategy, you may choose to exchange into different types of properties in different geographic locations.
4. Elimination Of Active Management Of The Investment
Operating a farm or ranch involves a lot of hard work. Exchanging farm and ranch land into other passive real estate investments or into properties that are professionally managed, may enable you to free yourselves of the day-to-day activities of running your farm or ranch. Ironically, an agricultural family can often sell their place and increase their income without having to work nearly as hard for it.
5. Wealth Building
The greatest potential benefit from using a 1031 exchange may be the ability to preserve all of the equity in the property you are selling. Deferring taxes on a sale allows the seller to reinvest the full sales proceeds, undiluted by tax. The ability to invest money that would have gone to taxes in additional real estate may enable you to generate more income for retirement and pass more wealth to your children and grandchildren. To see an example of the wealth building power of a 1031 exchange, see the next page titled Power Of A 1031 Exchange.
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