When 1031 Exchanges Go Beyond Expectations: Hidden Gems

1031 Pros
Aug 20
5 min read

A 1031 exchange allows you to roll your tax obligations from one property into another. With this method, you can keep more of your profits in circulation, and hopefully, they’ll continue to grow with time. While you may know how a typical exchange works, we’re about to show you some 1031 exchange examples that turned big profits for investors just like you.

What Is a 1031 Exchange?

A 1031 exchange is a coordinated transaction involving the sale and purchase of investment properties. Rules from the Internal Revenue Service say that the properties must be used for investments (not primary homes), and they must be like-kind.

In a typical 1031 exchange, an investor sells something like a single-family rental home and buys a slightly nicer single-family home in a coordinated transaction. The investor uses a qualified intermediary to facilitate the exchange, ensuring that the money never comes into the investor’s possession. The taxes that the sale would trigger are rolled into the new property purchased.

The investor keeps track of the diverted taxes throughout the ownership of the property. If the investor sells the property, those taxes are due. Alternatively, the investor could use another exchange and push the tax obligations forward once more.

Why Do Investors Use 1031 Exchanges?

A 1031 exchange is much more complex than a simple real estate transaction. Investors must meet tight deadlines for these deals, and they need professionals to ensure that they don’t break the rules and incur a tax.

Investors go through all these steps due to the very real profits they can realize. Experts say that a typical exchange allows investors to purchase a property that’s 15.4% more valuable than they would buy without an exchange.

In other words, exchanges allow investors to put more money toward their next purchase. By keeping more profits in circulation, they could realize bigger gains in time.

1031 Examples to Inspire You

Now that we’ve explained what 1031 exchanges are and how they typically work, let’s dive into some examples of investors who used this technique to improve their financial future.

1. Consolidating for Retirement

Kelly and Jim are two investors who own several single-family rentals in the Houston area. They purchased the properties over a 10-year period, and they have no outstanding mortgage balances. To reduce their expenses, Jim performs all routine maintenance on the properties, while Kelly shows open homes and handles rental agreements.

While Kelly and Jim make a fantastic profit on their properties, they’re reaching middle age and want to spend more time with their grandchildren. However, selling all these properties at once could mean a huge capital gains tax.

Instead, Kelly and Jim participate in a 1031 exchange and purchase one property that included paid maintenance and rental staff. Assuming the total value of the homes is $1.5 million (split among five properties), here’s how much the couple saves.

	Sale Only	1031 Exchange
Total sale price	$1.5 million	$1.5 million
Capital gains tax (20%)	$100,000 (due)	$100,000 (deferred)
After-tax profits	$1.4 million	$1.5 million (invested in new property)

2. Entering a New Market

John owns a warehouse property in Atlanta that’s worth $800,000 on paper, which he purchased for $100,000 years ago. Unfortunately, the warehouse market in all of Georgia is crowded, and it’s been difficult for John to keep a tenant for more than a few months. He wants to start something new.

After working with a real estate agent, John finds out about an apartment building for sale for $850,000. He has $50,000 to invest, but uses a 1031 exchange for the rest of the transaction.

An approach like this allows an investor to try an entirely new business vertical without losing a lot of money on the first investment. This chart breaks down the profits:

	Sale Only	1031 Exchange
Total sale price	$800,000	$800,000
Capital gains tax (20%)	$140,000 (due)	$140,000 (deferred)
After-tax profits	$660,000	$800,000 (invested in new property)

3. Consolidating a Diverse Portfolio

An investor named Erin considers herself a real estate connoisseur, and as a result, she’s snapped up all kinds of properties in the Seattle area. She owns a total of five properties, including an office park, two condos, and two single-family homes. Her total portfolio is worth $900,000. Her initial investment was only $400,000.

Managing all these properties takes up much of Erin’s time, and she wants to try something new.

After careful consideration, Erin sells her properties and uses the profits to buy just one rental property. The other profits she rolls into a Delaware Statutory Trust, which automatically means she just gets the profits without having to manage the property.

Instead of managing multiple assets, she only handles one. And she keeps more of her profits. This chart breaks down the approach:

	Sale Only	1031 Exchange
Total sale price	$900,000	$900,000
Capital gains tax (20%)	$100,000 (due)	$100,000 (deferred)
After-tax profits	$800,000	$900,000 (invested in new properties)

4. Increasing Potential Profits

Some investors prefer to pay down mortgages as quickly as they can to keep profit margins up. However, others are comfortable with debt, as long as it allows them to purchase a valuable property with a reasonable chance of turning a profit. Mark is one of these investors.

Mark owns a rental home that’s worth $500,000. He still owes $100,000 on that mortgage, but he wants to purchase a property that’s worth $1 million. He could sell his property, pay off his loan, and use the profits as a downpayment on something new. Or he could try an exchange. He’ll need to work with banks to make this work, but in the end, he’ll have a better-performing asset.

This table explains how a transaction like this might work:

	Sale Only	1031 Exchange
Equity available	$400,000	$400,000
Capital gains tax (20%)	$80,000 (due)	$80,000 (deferred)
After-tax profits	$320,000	$400,000 (invested in new properties)

5. Cashing Out for Profit

Most investors like to keep their funds in place for as long as possible. But what if an emergency happens and you need cash? That happened to Anna. An unexpected medical issue left her with bills she couldn’t pay. She knew she needed to extract a little money from her investments, but she didn’t want to give up everything.

Anna has a rental home with $400,000 in equity. She spots another nearby she could purchase for $300,000 in an exchange. With this partial 1031 exchange approach, she’ll pay taxes on just the boot (or the profit of the sale), not the entire transaction. And she’ll still stay involved in the investment world.

This chart compares her options:

	Sale Only	1031 Exchange
Capital gain	$400,000	$100,000
Capital gains tax (20%)	$80,000	$20,000
Profits	$320,000 (money only)	$300,000 (equity in new property) and $80,000 (in money)

Get Help With Your Exchange

Whether you’re new to the investment field or you consider yourself an expert, we can help. At 1031 Pros, we specialize in exchanges for investors just like you.

We can provide guidance to help you protect your investment and preserve your equity. We can also work as your qualified intermediary and ensure you’re not hit with an unexpected tax bill. We’ll simplify the entire process for you. Contact us to get started.