Rental Property 1031 Tax Exchanges: Learn How This Tax Break Can Help You Build Wealth

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Rental Property 1031 Tax Exchanges: Learn How This Tax Break Can Help You Build Wealth

27 May 2021
 Categories: , Blog

Most people who choose to invest in rental properties do so in the hopes of building wealth and establishing a passive income that they can count on when the time comes to retire. If you share in these goals, you should know that taking advantage of rental property 1031 tax exchanges can truly help to make accomplishing these goals much easier. 

What Is A Rental Property 1031 Tax Exchange?

A rental property 1031 tax exchange is a tax break that is made available thanks to IRS tax code 1031. This tax code allows individuals to defer income and capital gain taxes associated with the sale of rental properties if certain criteria are met. These criteria include the need to use all proceeds from the sale of the rental property towards the purchase of another rental property, as well as requiring that this purchase take place within a rather short time frame. 

How Does This Tax Break Help To Build Wealth?

Under normal circumstances, the amount of money you have on hand to purchase a new rental property would be reduced by the amount of taxes that you were required to pay on the proceeds you receive from selling one of your existing properties. In some cases, you may find that this can significantly lower your buying power. However, when you choose to take advantage of 1031 tax exchanges, you will no longer need to worry about paying these taxes at the time the sale is made. This will allow you to invest the full amount of the sale into a higher-end rental property, which ultimately provides you with more equity and can even increase your overall monthly income by allowing you to purchase a property that commands a higher monthly rent. 

How Can You Put This Tax Break To Work For You?

While the rules concerning rental property 1031 tax exchanges are rather straightforward, timing the sale of your existing property and the purchase of your new property so that both events fall within the time frame outlined by the IRS can be a bit tricky. Even a minor mistake in executing these tasks can result in you becoming ineligible for a tax deferment under 1031 guidelines. For example, if the closing on your new property is postponed for any reason, you may no longer be able to utilize a tax exchange on the purchase of the property. This can be quite problematic in many cases since a failure to qualify for a tax break may not be sufficient grounds for you to back out of a real estate contract. For this reason, it is always best to work with a tax consultant or a real estate attorney when executing a rental property 1031 tax exchange.