A 1031 exchange serves as a valuable tool for real estate investors seeking to defer the payment of capital gains taxes when selling an investment property and reinvesting the proceeds. Without utilizing a 1031 exchange, a sale and subsequent purchase would result in capital gains taxes being owed on the difference between the adjusted basis and the sale price.
To illustrate, let's consider an example. Imagine you have owned a piece of land for five years, initially acquiring it for $250,000 along with associated acquisition costs. Over time, you invested $100,000 in improvements, bringing your adjusted basis to $350,000.
If you decide to sell the property for $600,000, you would be liable for capital gains taxes on the $250,000 difference. Depending on your tax bracket, this could amount to $50,000 if you are in the highest bracket.
Let's consider an alternative scenario where you opt for a 1031 exchange, adhering to the procedures and timelines set forth by the IRS, to reinvest the proceeds from the sale into a new property. This strategic approach enables you to invest the entire $600,000 rather than just $550,000, creating a significant financial advantage. Key requirements for a successful 1031 exchange include:
While a 1031 exchange for investment property construction entails a complex transaction and tight timelines, the tax deferral can provide an opportunity for increased leverage in the reinvestment process. Additionally, utilizing this tool for subsequent investments can lead to a transfer upon your passing, whereby the heir receives the property at its stepped-up value, ultimately eliminating any deferred taxes.
If you have aspirations to build on the replacement property acquired through a 1031 exchange, there are avenues to pursue. The approach depends on the initial value and condition of the replacement property:
In conclusion, while it is possible to transact a 1031 exchange into new construction, there are important considerations to keep in mind. The replacement property must meet the requirement of being equal to or greater in value than the relinquished asset. If you plan to sell a retail property and embark on constructing a multifamily housing structure on vacant land, there are additional complexities involved.
If the value of the new asset already matches that of the original property, the process is straightforward. However, if the new acquisition initially holds a lower value due to ongoing construction, it must be completed within the 180-day exchange period. Throughout this period, the title should be held by a qualified intermediary.
To successfully navigate a 1031 exchange into new construction, it is vital for investors to diligently follow the rules and timelines set forth by the IRS. Engaging the services of a skilled intermediary can provide invaluable assistance in ensuring compliance and facilitating a smooth transaction. By carefully adhering to the guidelines and working with experienced professionals, investors can leverage the benefits of a 1031 exchange while pursuing their new construction projects.
Not an offer to buy, nor a solicitation to sell securities. All investing involves risk of loss of some or all principal invested. Past performance is not indicative of future results. Speak to your finance and/or tax professional prior to investing. Any information provided is for informational purposes only.
Securities offered through Emerson Equity LLC Member: FINRA/SIPC. Only available in states where Emerson Equity LLC is registered. Emerson Equity LLC is not affiliated with any other entities identified in this communication.
Perch Financial LLC and Emerson Equity LLC do not provide legal or tax advice. Securities offered through Emerson Equity LLC Member FINRA/SIPC and MSRB registered. Emerson Equity LLC is unaffiliated with any entity herein. 1031 Risk Disclosure:
No offer to buy or sell securities is being made. Such offers may only be made to qualified accredited investors via private placement memorandum. Risks detailed in a private placement memorandum should be carefully reviewed, understood, and considered before making such an investment. Prospective strategies and products used in any tax advantaged investment planning should be reviewed independently with your tax and legal advisors. Changes to the tax code and other regulatory revisions could have a negative impact upon strategies developed and recommendations made. Past performance and/or forward-looking statements are never an assurance of future results.
Many of the investments offered will be only available to those investors meeting the definition of an Accredited Investor under SEC Rule 501(A) and offered as Regulation D private placement securities via a Private Placement Memorandum (“PPM”). Prospective investors must receive, read, and understand all the risks associated with buying private placement securities. Investments are not guaranteed or FDIC insured and risks may include but are not limited to illiquidity, no guarantee of income or guarantee that all tax advantages or objectives will be met and complete loss of principal investment could occur.
Risk Disclosure: Alternative investment products, including real estate investments, notes & debentures, hedge funds and private equity, involve a high degree of risk, often engage in leveraging and other speculative investment practices that may increase the risk of investment loss, can be highly illiquid, are not required to provide periodic pricing or valuation information to investors, may involve complex tax structures and delays in distributing important tax information, are not subject to the same regulatory requirements as mutual funds, often charge high fees which may offset any trading profits, and in many cases the underlying investments are not transparent and are known only to the investment manager. Alternative investment performance can be volatile. An investor could lose all or a substantial amount of his or her investment. Often, alternative investment fund and account managers have total trading authority over their funds or accounts; the use of a single advisor applying generally similar trading programs could mean lack of diversification and, consequently, higher risk. There is often no secondary market for an investor's interest in alternative investments, and none is expected to develop. There may be restrictions on transferring interests in any alternative investment. Alternative investment products often execute a substantial portion of their trades on non-U.S. exchanges. Investing in foreign markets may entail risks that differ from those associated with investments in U.S. markets. Additionally, alternative investments often entail commodity trading, which involves substantial risk of loss.
NO OFFER OR SOLICITATION: The contents of this website: (i) do not constitute an offer of securities or a solicitation of an offer to buy of securities, and (ii) may not be relied upon in making an investment decision related to any investment offering by Perch Financial LLC, Emerson Equity LLC, or any affiliate, or partner thereof. Perch Financial LLC does not warrant the accuracy or completeness of the information contained herein.
