The 1031 Exchange Program

General Advice

OCT 3, 2021

I used to joke that I could never get excited for topics like bookkeeping, taxes, etc. At least that’s what I told myself when I failed Accounting201 the first time. Looking back now, what I was trying to say was that I didn’t see the significance of those topics in my life.

Fast forward a few years, and I’m excited to talk to you about the economic & cultural significance of my favorite IRS tax mechanism: The 1031 Exchange.

The ‘1031’ is a real estate transaction that allows the buyer/seller to defer taxes when you exchange ‘like-kind’ businesses, income, or investment properties.

Do you realize how awesome this is? I’ll rephrase:

If you sell a property at a profit, you’re allowed to defer all capital gains tax on the transaction as long as you re-invest the money into a like kind property!

Here’s a scenario to compare: Dave is a real estate investor & developer. He purchases an apartment building for $100k, and sells it for $150k in 5 years.

(1) Without the 1031: Dave pays a marginal tax rate of 36% on his gain of $50k. Uncle Sam pockets $18k, leaving Dave with $32k.

Dave now has $132k to invest into his next project. Great work Dave, time to get onto the next deal.

$132k re-enters the economy.

(2) With the 1031: Dave retains his full $50k profit.

Dave has $150k to spend, and Uncle Sam won’t tax him as long as Dave re-injects this money back into a similar project. More money is being spent in the economy, larger real estate projects, more housing, more jobs, etc.

$150k re-enters the economy.

My love for the 1031 program is a big component of why I chose to get into real estate. Uncle Sam is giving investors a piggyback to continue spending.

What are some of the cultural benefits of this program? Organizational and mom & pop investors will continue to inject money into neighborhood projects and developments. Landlords understand there is a surge in housing demand, exacerbated by the dearth of supply. Continued use of the 1031 program only encourages investors/developers/landlords to keep spending money in real estate.

Although only about 10-20% of real estate transactions involve the 1031, it’s the easiest way for a newcomer to scale up. With recent bills being proposed by the current administration, the 1031 is up for debate again as lawmakers figure out how to fund their aggressive economic policies.

I’ll share my thoughts in another post, for now the 1031 exchange has a special place in my heart <3


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