Paying taxes is not something that people enjoy. Not only does it mean having to give away money that is hard-earned, but doing so in a process that can be complicated and difficult to understand. Fortunately, however, there are many strategies that can help you navigate paying taxes and make this work for you.
One such strategy is what is called a 1031 tax exchange, named as such because it is based on Section 1031 of the tax code of the Internal Revenue Service. According to this provision, an individual is allowed to sell an existing property or piece of real estate and exchange it for another property of similar – or “like-kind” – value. Thus, the sale of your property, which normally would have been classified as a taxable event, can be deferred as such, which is why the 1031 tax exchange is also referred to as a tax-deferred exchange.
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Here are some of the primary advantages that employing the 1031 tax exchange brings:
Avoid paying capital gains tax
The ability to defer the payment of capital gains tax is one of the primary reasons why people choose to employ 1031 exchanges. Capital gains tax refers to the tax paid on the profit made when you sell a property at a higher value compared to its value at the time it was acquired.
What a 1031 tax exchange allows you to do is to use this profit and re-invest it by buying a different property. Thus, instead of losing this money to tax, you are able to instead use it to build up your investments and create more wealth. This makes it advantageous especially to investors who are seeking to build up as much of an asset base as they can.
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Diversify your investment portfolio
A 1031 tax exchange only requires that the two properties be of similar value, but not necessarily of the same nature. Thus, for example, selling a commercial piece of land and buying a new house would still qualify for a 1031 tax exchange, so long as they are valued at a similar amount.
This gives investors the perfect opportunity to branch out and diversify their investments. In the long term, this means that there is less risk associated with their portfolio as a whole. Given that a diverse portfolio is generally considered a positive and beneficial to investors, it only helps that diversification comes with all of the other benefits of a 1031 tax exchange.
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Increased freedom to invest
Allowing an investor to use money that would have been paid on tax for other investment opportunities encourages more people to invest and grow their personal wealth. This, in turn, helps promote an investing attitude and encourages people to use their money for activities that help increase their wealth and value.
Furthermore, it allows investors to easily sell properties that they feel they cannot manage properly. This way, the properties can continue to be productive and wealth-generating, instead of falling victim to poor management and disrepair.
Although taxes are commonly seen as a barrier to building wealth, there are ways to get around this and make tax laws and provisions work for you. Thus, so long as you know what you are doing, you get to continue to enjoy the benefits of investing and growing your wealth, without having to worry about any associated taxes to pay.