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1031 Exchange for Investment Properties

A 1031 exchange refers to Section 1031 of the U.S. Internal Revenue Service’s tax code. It states that if an individual exchanges one investment property for another, via the 1031 exchange, they may be able to defer the capital gains that they would otherwise have to pay at the time of the sale. Ultimately, this is a wise investment strategy that allows individuals to build wealth through real estate investments. 

When it comes time to choose a real estate agent to sell your investment property, you want to be sure that you work with someone who is experienced in investment strategies such as 1031 exchanges.

What Properties Qualify? 

The tax code states that an individual can sell income, investment, or business property and replace it with a like-kind property. What that means is real estate properties that are “of the same nature or character, even if they differ in grade or quality.” 

Common types of like-kind real estate:

  • Apartment buildings
  • Commercial properties
  • Condo units
  • Duplexes
  • Hotels
  • Industrial buildings
  • Office buildings
  • Restaurants
  • Self-storage
  • Vacant land 

Types of real estate that do not qualify:

  • Personal residences
  • “Fix and flip” properties 
  • Second homes
  • Vacation homes

However, in some instances, vacation or second homes may qualify for a 1031 exchange if they are held solely as rentals. To be safe, a professional who is well-versed should be consulted regarding all potential 1031 exchanges. 

Additionally, the property being exchanged must be of greater or equal value, and you must not receive a “boot.” “Boot” is essentially the difference if the property being exchanged is of lesser value. This would constitute as a partial 1031 exchange, which can still be beneficial, but the difference, or “boot,” from the exchange will be taxed. For example, if your original property is sold for $4,000,000 and the property you want to exchange is worth $3,000,000, then you would have to pay capital gains tax on the $1,000,000 “boot.” 

Like-Kind Properties & Capitalization Rates

Many investors use a capitalization rate, or cap rate, to determine the potential return on a commercial real estate investment. It is a useful tool when comparing the relative value of similar real estate investments such as like-kind properties. 

The cap rate is based on the net income which the property is expected to generate. It is represented as a percentage and is calculated by dividing net operating income by property asset value. There are other ways of calculating the cap rate, but this method is the most popular. The percentage also helps illustrate the amount of time it will take to recover the invested amount in a property. When completing a 1031 exchange in Princeton, NJ, the cap rate is important to take into consideration.

Benefits of 1031 Exchanges

If you are considering selling and buying investment properties in Robbinsville, Princeton, or the surrounding New Jersey and Pennsylvania areas, then you’ll want to explore and consider the benefits that 1031 exchanges offer. 

The main benefit of a 1031 exchange is that you can avoid paying capital gains taxes right away. Instead, you will be able to take your profits to invest in new, income-earning properties. 

There are a few things you need to be aware of before deciding to execute a 1031 exchange. First, you will need to choose your new property within 45 days of selling the old one. Second, the exchange of properties must be complete within 180 days. If the exchanges are not executed within these timelines, the capital gains will be subject to taxes. 

Lastly, to properly complete the exchange and adhere to the strict tax laws, you will need the help of an experienced real estate broker and sometimes an accountant or attorney. Timing is everything and someone like myself will be able to help you navigate the waters. 

Real Estate Agent with 1031 Exchange Expertise 

If you are in the early stages of investing in commercial properties in Robbinsville or Princeton, NJ, or if you are a seasoned investor, you’ll need a third party to help you execute a 1031 exchange successfully. In my 14 years of real estate experience throughout New Jersey and Pennsylvania, I have helped countless investors build their wealth through 1031 exchanges. To learn more about your options, contact me today by calling 609-369-1267.