As a property investor in California, you may have heard how IRS Section 1031 allows you to exchange properties and defer capital gains taxes. The tax deferment enables you to redirect proceeds fully into a new investment and potentially acquire a higher-value property. However, Section 1031 insists that the properties being exchanged fit the definition of “like-kind.”
Examples of like-kind properties
The properties being exchanged do not have to be identical. To complete a 1031 exchange, both properties must have a business-oriented purpose. The property may be a commercial property or almost any type of investment property. However, your personal residence would not meet this criteria.
Acceptable exchanges would be:
- Motel swapped for retail strip mall
- Warehouse swapped for apartment building
- Rental condo swapped for rental single-family home
- Farmland swapped for industrial building
Portfolio growth with 1031 exchanges
As mentioned, the deferment of capital gains taxes through the 1031 exchange lets you keep all the equity earned from the sale. That equity can then increase your down payment on the next property. A higher down payment combined with financing maximizes your spending power as a property investor.
Values of commercial properties vary according to their use. An opportunity to sell one commercial property at a good price could empower you to reinvest in another commercial property of a greater value than you could otherwise afford.
The IRS does not allow you to defer taxes indefinitely. To take advantage of this strategy, you will need to coordinate the sale and purchase closely. Investors often manage to complete the exchange on the same day, but you do have 45 days to find a new investment property and 180 days to finish the deal.