The IRS Code has a well kept secret that some real estate investors have used over the past decades to defer taxes and create generational wealth.
This is called the Section 1031 Exchange.
Section 1031 Exchange allows you to sell a piece of appreciated real estate and defer the taxes as long as invest the entire proceeds into a like kind property.
Section 1031 Exchange along with Cost Segregation studies can create massive tax savings.
Here is a quick example of how this works!
- In 2000 you bought a rental home for $500,000.
- Over the past twenty years you wrote off deprecation deductions of $290,000, so paying very little to no tax on your rental income.
- In 2020 you sell the property for $750,000
- Ideally, your taxable gain would be $750,00- ($500,000-$290,00)= $440,000
- Tax on that gain at 20% would be around $90,000
However, if you do a 1031 exchange, you can hire a third party administrator to hold the proceeds of your home sale in an escrow account. You identify the next property to purchase within 45 days and then close on the property within 180 days of the sale of your initial property.
The Results
- You roll the gain into a bigger property. Say the home purchased in 2020 for $500,000 still had a $75,000 loan on it when you sold it. So your net proceeds were $750,000-$75,000=$675,000
- You take the $675,000 and use it as a 20% Down payment to buy a $3,300,000 property
- Final Result: You saved $90,000 in taxes. You used the saved taxes along with the proceeds from the sale to buy a much larger property which will increase in value at a greater dollar value. For example, you started with a single family rental home but now your $3,300,000 property is a commercial business property likely to grow in value faster than a home.
- You continue to do this over your life time and in essence never pay taxes on the gain!
The above is a simplified example of how you can use real estate to build generational wealth by investing your business profits into real estate over the long run.
Next Month we will go over a case study with real client numbers! Stay tuned.
For questions please feel free to contact one of our Virjee Consulting team members by calling 713-396-3172 or emailing omar@virjeeconsulting.com
Disclaimer- Advise in this blog should not be taken as tax advise. Each person’s tax circumstance is different and unique. Using these strategies without full knowledge of the current IRS rules and regulations regarding the specific items discussed can result in heavy fines, penalties and interest. Please discuss the guidance in this document with a tax expert before making any decisions.
