In my last post I talked about doing 1031 exchanges with real estate timing as a way to pay ZERO capital gains taxes when you sell a piece of property.
This is a great strategy to really build your wealth because you can grow it so much faster if you aren’t having to pay a huge chunk of money to the government each time you sell. However, I also pointed out that 1031 exchanges are tax deferred, meaning that eventually the government wants their money. They’ll get it as soon as you sell a property and actually keep money from the sale.
So is there a legal way to avoid this? You bet there is. You’ve got several options.
Let’s look at the first choice. Let’s say you use the real estate timing market momentum charts to buy a real estate investment and then down the road when the momentum charts say its time to sell you want to sell and move only part of your profit into another property. You want to keep some of that income for yourself. Any portion of the income you keep would be subject to capital gains tax. Wouldn’t it be nice to not have to pay any tax on that?
Here’s a good way to do this. When you sell the first property and move your profits via 1031 exchange into the next real estate investments, hopefully more than 1 now so you can really grow your wealth, move ALL of the profits into the next investments. Stay with me here, I’m going to explain how you’ll get to keep some of it. After you meet any seasoning requirements necessary do a cash out refinance on one of the investments. This way you can get that money without it being a taxable event!
Let’s say you’ve been doing 1031 exchanges for a while now, you’ve really made some money in real estate investing but you are ready to retire. Now if you were to just sell your real estate investments the tax man would come calling wanting Uncle Sam’s cut. So what do you do? There are a couple of options here and I like the idea of using a blend of them.
First, let’s say you want to get a big chunk of money out. Here is a creative way to handle it. Do one more 1031 exchange. You’re going to sell off some of the investment properties and use that money to purchase another home via 1031 exchange. Let’s say for example you sell off 2 properties for $200,000 each and then move the money via 1031 exchange into a much nicer, beach front, single family home for $400,000. You need to turn that home into a rental for at least one year. Then after the rental period you can turn it into your principal residence. If you choose, you can sell your existing principal residence and take advantage of the principal residence tax deduction (the first $250,000 is tax free if you are single, $500,000 if you are married). You may also want to keep the family home, that’s completely up to you. The point is that this second home needs to become your principal residence for at least 2 years, then you can sell it and use that principal residence tax deduction to take your 1031 exchange profits out – TAX FREE!
Do you see how that works? You did a 1031 exchange into a single home. You have to rent it for a period to meet the 1031 requirements and then by you living in it for 2 years it becomes your principal residence and qualifies for the principal residence deduction so when you sell it those profits are now tax free.
Obviously you’ll need to meet the 1031 requirements and the principal residence deduction requirements to do this. I’m certainly no tax advisor so I recommend you talk with one as well as a 1031 specialist to do this right.
Myself, I also really like the idea of having rental income when I retire. Real estate is how you build wealth, it’s also how I think wealth should be kept. That way when you retire you have that rental income coming in no matter what you do. A common expression the wealthy use is “never touch the principal.” In other words live off the income the principal generates without depleting the principal that way you’ll always stay wealthy. That’s exactly how rentals work. You keep the principal in place, the real estate investment, and live off the rental income when you retire.
So when you are ready to retire you can do 1031 exchanges and move your many real estate investments into a couple or few apartment buildings. Remember, the tax man only gets paid from the tax deferred exchange if you keep the money from the sale. If you sell those properties and do a 1031 exchange into apartment buildings that you are going to keep for the rest of your life you don’t have to pay the tax. Then you can live out your days with rental income coming in each month no matter what you do.
I know this is a long post, but I’ve got one more idea to throw out as well. Normally when you hold a rental property you take a depreciation deduction to help reduce the amount of tax you have to pay off the rental income. This depreciation deduction would be subject to recapture when you sell the property. But NOT if you do a 1031 exchange!
Just remember to please talk with a tax advisor who understands 1031 exchanges so you can really make this work for you. Also talk to a 1031 exchange specialist so you do that properly.
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