A 1031 tax-deferred exchange is paramount to successful real estate investment as it enables you to scale up your portfolio and maximize the benefits. But how exactly does a 1031 exchange work? Typically when you sell an investment property, you have to pay capital gains tax during the time of the sale. Although the amount you pay depends on your income bracket, you are likely to be federally taxed about 10-20% on any capital gains.

But when you carry out a 1031 exchange, you get to defer on the capital gains tax and reinvest the property sale proceeds into a new property of like kind, equal or greater value. Discover the benefits of investing in dst 1031 properties.

You get an opportunity to invest in a portfolio.

As earlier mentioned, to carry out a 1031 exchange, the properties involved must be of a similar kind, which means real estate assets of similar nature. They cannot include your primary residence property. One of the good things about a 1031 exchange is diversifying your portfolio to get better returns over time. For example, you can swap a single-family home investment property in a highly appreciated market with several rental properties in an affordable market hence better cash flow.

You can reset your depreciation.

The IRS recognizes 27.5 years for the depreciable period of an investment property. That means you can subtract the property’s value divided by 27.5 from your taxable income amount for every year you own the investment property. Even if you have improved the property, you only get the depreciation amount based on the initial buying price of the property. But with a 1031 exchange, you can reset the depreciable amount of your investment property to a higher value with a more significant tax benefit every year.

You are exposed to new markets.

A 1031 exchange allows you to diversify your risks and capitalize on the advantages of real estate investments. Since 1031 exchanges are not confined within state lines, you can execute a 1031 exchange to get your foot on a market with a higher growth potential hence bugger future returns. But remember that some states might require you to pay capital gains tax while others do not.

Exchange for high-value properties

A 1031 exchange enables you to trade up for a higher value property to match your real estate investment goals. For instance, you can swap one investment property for another with prospects of higher returns without paying the taxes o the new investment.

It enables you to build equity over time.

Did you know that you are not limited to the number of 1031 exchanges you can execute? That is good news because you can begin with a modest investment and gradually trade up until you have a real estate empire.

The bottom line

You can invest in 1031 exchange properties to save on taxes, diversify your portfolio, and build wealth as a property investor. It is a good strategy if you want to sell an existing property and reinvest the proceeds of the sale with similar property with a higher cash flow.