Posted 08-02-2008 6:24 pm by
With the new Presidential Election coming, capital gains tax may go up from 15% to 20%. If it does, there will be a lot more 1031 exchanges happening. Is a 1031 exchange right for you?
Performing a 1031 exchange only makes sense when it fits sound investment principles. Too many investors buy an inferior property or overpay for the property they are exchanging into, because by law, you have to find and close on your new property within certain time limits or the exchange fails. It is this time pressure that causes investors to act emotionally and end up making a poor investment decision.
A 1031 exchange allows you to defer your capital gains tax when you sell your property. Rather than paying 15% of your gains to the government, you can roll it into the next property. Having the extra 15% that you do not have to pay in capital gains taxes now can be substantial when you consider how much more property you can buy, especially when you take compound interest into consideration over time. When you sell your next property, you can perform another 1031 exchange and defer the capital gains taxes again unil you sell the next property. You can do as many 1031 exchanges as you want, until the time you pass away, when you may be able to eliminate paying the huge capital gains bill you have accumulated throughout your lifetime using a charitable remainder trust. I am not a CPA or attorney, so you should consult with a qualified professional regarding your tax and legal obligations.
What I do know is that investors make bad investment decisions because they are occupied with avoiding this 15% capital gains tax. When you perform a 1031 exchange, you have to find a new property within certain deadlines. If you don't, the exchange fails and you need to pay up the 15% in taxes. What I see more often than not is that people find a bad property to exchange into, or overpay for the new property because they want to "save money" by avoiding the 15% in taxes. It is much worse to buy a bad property or overpay for the new property! I would rather pay the 15% in taxes than ending up with a bad property due to the time pressure!
To alleviate the time pressure, you may consider performing a reverse 1031 exchange, where you can buy the new property before selling the existing one you have. A reverse 1031 exchange ensures that you can identify and negotiate good terms on a good property before you sell the one you have, which reduces the time pressure dramatically. The downside of doing a reverse 1031 exchange is that it is more expensive, but I think it is much more expensive to make a bad investment decision under time pressure than to pay your qualified intermediary a few more dollars.
A 1031 exchange has its pros and cons, and only do it when it makes investment sense. I would highly suggest doing a reverse 1031 exchange. Despite the higher costs, it reduces the time pressure so you can make a good investment decision.
---Written by Oliver Wu
Oliver Wu | Advantage Commercial Brokers
The Commercial Broker for
Small Business Owners in Puget Sound
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E-mail: oliver@acbrokersinc.com
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