Article - Detail
1031 Exchanges
The Government Now Giving Investors Free Capital
Gregory E. Grahn - August 10th, 2008Suppose there is a governmental program that will give real estate investors free capital for greater investment; allowing them to buy more property and to better leverage their portfolio. Now imagine that the terms for the free capital are as follows:
- 0% interest – Investor pays no interest on the money the government gives them.
- High LTV - The capital can be leveraged at the investor's highest LTV capability.
- No Due Date – Investor perpetually keeps the money as long as they have it invested in real estate.
- 85% Free Profits – The investor keeps 85% of what the government's (leveraged) money makes them—these are free profits from an outside money source.
- Potential Non Re-Payment - With proper long-term investment practices and proper financial planning, the investor may be able to avoid fully paying back the government's money (this may also include not having to pay back any depreciation recapture).
Sound good? It is already available . . . it is a 1031 Tax deferred exchange.
1031 Exchanges remain one of the most powerful investment tools, yet they are also one of the most misunderstood and under-used.
Most articles written on 1031 exchanges provide little help in this area because they focus solely on the mechanics of the changing IRS regulations, not on the freedom and opportunities that are 1031 Exchanges provide. 1031s were initiated by the government with the simple purpose of helping investors increase their returns through continual investing. Investors need to understand that 1031s were created for their benefit . . . they need to understand how they can use these benefits, and how they can best strategize to maximize the future growth of these benefits.
The most common misconception with 1031 Exchanges is that they save you money. The thought process goes something like this: "if I do a 1031, I don't have to pay the government their taxes this year; thus I saved a little bit of money." However, there two major problems with this line of thinking: First it is not true; 1031s by design only defer an investor’s tax obligation, thus the investor still owes the money and has not saved a penny. Second, this thought process requires the investor to look backwards at the property sold as a profit source – not forward at the properties to be purchased . . . and for an investor, looking backwards instead of forwards inevitably decreases their returns.
The irony of not understanding the profit-value of a 1031 is that so many people understand the profit-value behind IRA's and 401(k)s – they are relatively similar. The benefit behind the retirement vehicles is that the money put into the investment compounds in a tax-free environment. Because the investment is not internally taxed, it remains larger and thus creates greater profits. The investor may ultimately pay taxes on withdrawal, but the since the taxes are only a percentage of the earnings, the investor freely retains a greater net wealth without added personal contribution. 1031s follow this same concept, by deferring the tax obligation on the investment's gains, the investor has a greater core of capital from which to make more money . . . and then in the end, the investor only pays a portion of taxes on what was earned (and sometimes, pays none at all).
Accelerated benefits of 1031s – beyond those of IRA's and 401(k)s — further come from the fact that real estate allows for leveraging. Through leveraging, the compounding benefits of pre-taxed money increase in scale. Additionally, the tax-free advantage can also quicken an investor's roll-over time with any given property; thus allowing investors to not only multiply their returns, but do so at a faster compounding rate. So in short, tax free benefits of 1031 Exchanges can increase capital, increase returns, increase compounding, and increase the turnover of investments – all without adding any additional risk -- and often reducing risk. Regardless of market conditions, 1031 exchanges, when utilized properly, should provide immediate and future benefits to the investor.
The tax free growth of real estate -- especially through self-directed IRAs -- is growing in popularity.
To learn more about the advantages of self-directed IRAs and the ability to purchase real estate, click on either of the following links:
Freedom Day Consulting Services, Inc. or Guidant Financial Group.
But whereas self-directed IRAs are relatively new, 1031s have been around for over seventy years. And despite their massive financial strength,
1031s remain woefully unfamiliar and untapped. Investors need to be more proactive; they need to realize that the common avenues for real estate advice (Realtors, Loan Officers, etc), do not adequately cover the positive application and benefits of 1031 Exchanges. Investors should to take time out on their own to learn how 1031s can best be implemented into their own investment strategies. There is no question that 1031s will strengthen an investor's returns. The only question is by how much. So take the time to learn more about 1031s in general; then take the additional time to speak with a 1031 professional and learn how they can apply to specific investment goals.
Although 1031 are not inherently restrictive in their application, there are numerous rules and regulations that should be discussed as part of the 1031 planning process. Click here to go to the author's website and/or to get more information on how to speak with him directly, free of charge at Puget Sound 1031.
Lastly investors may also wish to work with investment companies that incorporate 1031 strategies into their long term planning and growth (most investment groups do not do this).
One national investment group that utilizes 1031s, and contains web-materials in this area, is FDC Services Inc.
Whatever road the investor takes to gain knowledge on 1031s is a good one. Increased returns are closer and easier that one might imagine.
By: Gregory E. Grahn
President: Puget Sound 1031 Services
(360) 918-8904 / 1-866-464-3699
greg@pugetsound1031.com