1031 Exchange vs. Opportunity Zone: Understanding the Differences for Real Estate Investors

Real estate investors looking to maximize their tax savings and investments have two popular options: 1031 exchanges and opportunity zones. While both strategies offer benefits for investors, they have different requirements and advantages.

A 1031 exchange allows investors to defer paying capital gains taxes on the sale of an investment property by reinvesting the proceeds into a like-kind property within a specific time frame. This allows investors to reinvest the full amount of their proceeds into a new property, giving them more buying power and the potential for greater long-term gains. However, 1031 exchanges require strict adherence to specific timelines and rules, including a 45-day identification period and a 180-day exchange period.

On the other hand, opportunity zones provide investors with tax incentives for investing in designated low-income areas. By investing capital gains into a qualified opportunity fund, investors can defer paying taxes on their gains until 2026 and potentially reduce their tax liability on those gains. Furthermore, if the investment is held for at least ten years, any gains from the investment can be tax-free. However, opportunity zones require investing in specific areas and meeting other requirements, including using a qualified opportunity fund.

Overall, both 1031 exchanges and opportunity zones offer tax benefits and investment opportunities for real estate investors. The choice between the two depends on the investor's goals, timelines, and investment strategies. It's important to consult with a qualified intermediary and tax professional to determine which option is best for your specific situation.

In conclusion, understanding the differences between 1031 exchanges and opportunity zones can help real estate investors make informed decisions about their investments and maximize their tax savings. Be sure to do your research and seek professional advice before making any investment decisions.

"5 Common Mistakes to Avoid with 1031 Exchanges: A Guide for Investors"

"5 Common Mistakes to Avoid with 1031 Exchanges: A Guide for Investors"

A 1031 exchange is a powerful tool for deferring capital gains taxes on investment properties, but it can be a complex process that requires careful planning and execution. Unfortunately, many people make common mistakes that can derail their 1031 exchange and lead to costly consequences. In this post, we'll take a look at five common mistakes people make with 1031 exchanges and how to avoid them.

1. Failing to meet deadlines: One of the most common mistakes people make with 1031 exchanges is failing to meet the strict deadlines outlined by the IRS. To qualify for a 1031 exchange, you must identify a replacement property within 45 days of selling your original property and complete the exchange within 180 days. Missing these deadlines can result in disqualification and the loss of potential tax benefits.

2. Not selecting the right replacement property: Another common mistake is selecting a replacement property that doesn't meet the IRS requirements for a 1031 exchange. For example, you must purchase a property that is of equal or greater value than the property you sold, and you must use the property for business or investment purposes. Failing to select the right replacement property can also lead to disqualification and the loss of potential tax benefits.

3. Forgetting to account for all expenses: Another mistake people make with 1031 exchanges is failing to account for all expenses associated with the transaction. This can include closing costs, transfer fees, and other expenses that can eat into the tax benefits of the exchange. To avoid this mistake, it's important to work with a qualified intermediary who can help you account for all expenses and ensure that you're maximizing your tax savings.

4. Using funds from the exchange for personal use: Another common mistake is using funds from the exchange for personal use. The IRS requires that all funds from the sale of the original property be held by a qualified intermediary until they are used to purchase the replacement property. Using these funds for personal use can result in disqualification and the loss of potential tax benefits.

5. Failing to consult with a qualified professional: Perhaps the biggest mistake people make with 1031 exchanges is failing to consult with a qualified professional. The rules and regulations surrounding 1031 exchanges can be complex, and even small mistakes can result in disqualification and the loss of potential tax benefits. By working with a qualified intermediary and consulting with a tax professional, you can ensure that your 1031 exchange is executed properly and that you're maximizing your tax savings.

By avoiding these common mistakes and working with qualified professionals, you can ensure that your 1031 exchange is successful and that you're maximizing your tax benefits.

What are Direct and Indirect Property Investments?

There are many options when it comes to building wealth including direct and indirect property investments. We take a look at basic differences between these investments by exploring their advantages and disadvantages.

Direct Real Estate Investing

When you invest in a direct property, you are investing in real estate investments. Some examples include commercial property, industrial, or residential assets. Investors in direct property investment earn profit through a number of ways: rent, appreciation, and income from business activities in the property.

Pros and Cons of Direct Real Estate Investing

Is direct real estate investing for you? Let’s explore the pros and cons.

Pros

One key advantage to direct real estate investing is its ability to generate stable income. Another benefit to investing in direct real estate is the freedom you have when it comes to making decisions for your property.

In addition, these investments lend itself to tax advantages including deducting specific expenses such as:

• Property management costs

• Property repairs

• Mortgage interest

• Property tax

• Property conservation and maintenance

Aside from the above tax benefits, depreciation also allows investors to deduct costs related to the maintenance and improvement of your property throughout its expected lifetime. Depreciation takes into account the property’s decrease in value from normal wear and tear. Conversely, appreciation will generally increase property value and could allow you to sell it for more.

It’s important to note that depreciation is not permanent. If or when the property is sold, the depreciated amount will be regained and taxable up to a rate of 25%. One way to defer this tax liability is through a 1031 exchange. 

Cons 

With the passive income that your property generates comes the responsibility of maintaining and managing it. You have to be prepared to handle emergencies and liability. Fluctuations in the market could also make it difficult to maintain or find new tenants. For instance, the pandemic has put residential and commercial property owners in difficult financial spots with their loans (e.g., defaulting), as some tenants are unable to cover their rental expenses. Finally, if you do need immediate cash, unless you can sell the property in time, you may need to find another source in case of an emergency. 

Pros and Cons of Indirect Real Estate Investing

Now we turn to indirect real estate investing. For new investors who wish to diversify their portfolio and reduce risk, a real estate investment trust or REIT can be a good option. REITs are publicly traded companies that own, operate, and finance income-generating real estate. REITs pool money from investors, which is similar to mutual funds. 

Pros 

As mentioned above, REITs lend themselves well to low risk and high dividend yields. Unlike  direct real estate investments, investing in REITs means that you generate income without having to own, manage, or finance your properties. The cost to invest in REIT is also lower compared to direct investing. In addition, direct real estate investments are not liquid. With REITs, you can readily buy and sell shares.

Another benefit is that REITs offer enticing total return potential. By law, REITs have to pay at least 90% of taxable income to shareholders, and it's not uncommon to have a 5% dividend yield—or more. REITs also have to potential for capital appreciation as the value of the underlying assets increases.

Cons of REITs

Of course, there are some drawbacks to REITs. For starters, most REIT dividends aren't considered "qualified dividends," so they're taxed at a higher rate. This is something to pay extra attention to if you own REITs in a taxable brokerage account. Keep in mind that you can hold REITs in a tax-advantaged Roth IRA account.

Another con is that REITs can be very sensitive to interest rate fluctuations, and rising interest rates are bad for REIT prices. In general, REIT prices and Treasury yields have an inverse relationship: when one goes up, the other goes down, and vice versa.

One other drawback is that while REITs can help you diversify your overall investment portfolio, most individual REITs aren't diversified at all. That's because they focus on a specific property type—such as offices or shopping centers. If a REIT invests solely in hotels, for example, and the economy tanks or people stop traveling (think COVID-19), you can be exposed to property-specific risks.

Which Type of Investment is Right for You?

Both direct real estate investments and REITs have their advantages and drawbacks. For its tax advantages, engaging in a 1031 exchange is an excellent option. Our team at Growth 1031 is a proven source of reliable information, a trustworthy ally in areas of uncertainty, and the standard bearer for client relationships. To learn more about 1031 exchanges or to get started with the process, schedule your initial consultation with us today!

Understanding Reverse 1031 Exchanges

What is a Reverse 1031 Exchange?

You’ve heard of the 1031 exchange (if not, now would be a great time to check out our blog post on this!). But what are reverse 1031 exchanges and how do they work?

To recap, 1031 Exchanges allow investors to swap an investment or business property for like-kind property of equal or greater value while deferring capital gains taxes. If your property meets the requirements, you can exchange it for another investment or property and have limited or no tax due at the time of the swap.

What Exactly is a Reverse Exchange?

A reverse exchange is a type of property exchange wherein the replacement property is acquired first, and then the current property is traded away. A reverse exchange was created to help buyers purchase a new property before being forced to trade in or sell a current property. This may allow the seller to hold a current property until its market value increases, thereby also increasing their own timing to sell for maximized profit.

The Reverse Exchange is the opposite of the Delayed Exchange. Where the Delayed Exchange requires the Exchangor to relinquish property before he acquires property, the Reverse Exchange allows the Exchangor to acquire property first and relinquish property second. In other words, the Reverse Exchange allows an investor to acquire a new property today, when an excellent investment may be available, and sell other property later when a better price might be obtained.

The Reverse Exchange greatly expands the ability of the investor to take advantage of changes in the marketplace and to improve his or her investment position.

Standard like-kind exchange rules usually do not apply to reverse exchanges. Such rules typically allow a property investor to discontinue payment of capital gains taxes on a property they have sold so long as the profit from that sale is applied toward the purchase of a “like-kind” property. The IRS has created a set of safe-harbor rules that allow for like-kind treatment, as long as either the current or new property is held in a qualified exchange accommodation arrangement, or QEAA. Additionally, the investor cannot use property already owned as a replacement for the relinquished property. 

Reverse exchanges apply only to Section 1031 property, so it is also referred to as a 1031 exchange. Section 1031 properties are properties that businesses or those with qualifying organizations exchange in order and defer paying taxes on any profit gained from their sale. However, it’s not as simple as an individual taxpayer buying one property, selling it, then using the profits to buy another property. Instead, there must be a set standard of exchange as well as the presence of a facilitator who is used to set up the process. Section 1245 or 1250 properties are ineligible for this type of transaction.

Reverse 1031 Exchange Requirements

Generally, there is a maximum holding period that applies to properties in reverse exchanges, typically averaging around 180 days. The opposite of a reverse exchange is the delayed or deferred exchange, in which an exchanger must first relinquish owned property by trading or selling before acquiring a new property. 

Reverse exchanges are often used in cases where a property investor must close on the sale of a new property before being able to sell their current property. Cases such as these include the unexpected discovery of a desirable new property that must be purchased within a short amount of time or situations in which the sale of a currently-held property falls through unexpectedly, thus leaving a reverse exchange as a potential fix that allows the investor to continue the purchase of a new property. 

Reverse 1031 Exchange Terms to Know

Qualified Exchange Accommodation Arrangement (QEAA)

A qualified exchange accommodation arrangement or QEAA is the exchange agreement between you, the taxpayer, and the EAT. The QEAA is meant to be a safeguard to hold properties during an exchange as a shelter from taxes. 

Under the IRS’ Revenue Procedure 2000-37, if an investor meets the requirements of a QEAA, they won’t be taxed upon exchange of the properties. There’s been some grey area regarding which assets qualify under this revenue procedure. Near the end of 2019, the IRS finally clarified that rental real estate qualified for these safe harbor benefits. 

Before executing a QEAA, it’s wise to already know which property you’re going to buy and how it will be funded (cash, financing, etc.).  

Exchange Accommodation Titleholder (EAT)

The taxpayer and EAT must both agree to and follow the QEAA. Because investors are not allowed to hold the title of the property they’re relinquishing for the duration of the exchange, the EAT acts as a holding cell. 

Think of the EAT as an LLC. Essentially, the EAT buys the property you’re getting rid of, at fair market value, and becomes the titleholder for tax purposes. When your rental property sells, the money from the sale is used to purchase your replacement property. 

Once you’ve purchased a replacement investment property and have a buyer under contract for your property–next you will need a Qualified Intermediary. 

Qualified Intermediary (QI)

The Qualified Intermediary acts as sort of a liaison between buyers, sellers and the IRS. The money from the sale of the property you turned over is transferred to the QI and used to “buy” the title from the EAT. The main responsibility of a QI is to transfer the titles of both properties from the EAT to their respective owners, which then completes the exchange. 

The QI ensures that the reverse 1031 exchange process was done correctly and qualifies the investor for tax advantages. 

Types of Reverse 1031 Exchanges

Exchange Last

The most common type of reverse exchange is an exchange last reverse. During an exchange last reverse, the EAT holds the title of the “replacement” or new property until your “relinquished” property is sold. 

The exchange last reverse gives investors more flexibility. On the other hand, it can present issues when working with certain lenders because their reverse 1031 exchange policies tend to vary. Call around to find out which lenders will work with the EAT keeping the property title during the exchange process. 

Exchange First

For an exchange first reverse, investors buy a new investment property directly through a lender and simultaneously turn the title over to the EAT. However, most lenders require you to reinvest all the equity from the property you sold into the replacement property. 

The problem is, money must be put toward the new investment property in order for the sale to become final. This means an investor will have to have a lot of cash-on-hand.

Ready to Explore Your Options?

As your qualified intermediary, Growth 1031 is experienced and fully equipped to facilitate your reverse 1031 exchanges. We walk you through all stages of the exchange and guide you through every step. Per California law, our Exchange Accommodators are also licensed and bonded for your peace of mind. Whether you want to learn more about 1031 exchanges or are ready to get into the exchange process, we’d love to hear from you! Contact Growth 1031 for a consultation today.

Disclaimer: Growth 1031, Inc. is a qualified intermediary that specializes in facilitating 1031 exchanges. Growth 1031, Inc.is not a law-firm and does not provide tax, legal or accounting advice.  You should consult your own tax, legal and accounting advisors before engaging in any transaction.

Benefits of Opportunity Zones and 1031 Exchanges

In this article we take a look at what Qualified Opportunity Zones are and the benefits these bring to both investors and communities.

What are Opportunity Zones?

An Opportunity Zone is an economically-distressed community where new investments, under certain conditions, may be eligible for preferential tax treatment. Localities qualify as Opportunity Zones if they have been nominated for that designation by the state, and that nomination has been certified by the Secretary of the U.S. Treasury via his delegation of authority to the Internal Revenue Service. Opportunity zones then help the economy grow by creating jobs in these distressed communities, while investors receive tax benefits.

The 2017 Tax Cuts and Jobs Act was signed into law in December 2017. Throughout all 50 states, the District of Columbia, and the US territories, there are more than 8,000 Qualified Opportunity Zones designated by the Secretary of Treasury. You can find the full list here.

Taxpayers are able to invest in these Opportunity Zones through Qualified Opportunity Funds (QOP). How do these work and who can qualify for the benefits?

Opportunity Zones mainly function as tax incentives to spur economic growth in undercapitalized communities. If you are an individual or a corporation with capital gains, you can qualify and take advantage of tax deferral. Individuals and corporations must completely fill out Form 8996, Qualified Opportunity Fund, with its federal income tax return. For additional information, see Form 8996 and its instructions. The return with Form 8996 must be filed timely, taking extensions into account. This same form is “used to annually report whether the QOF met the investment standard during its tax year” per the IRS

Benefits of Qualified Opportunity Zones

Investors can take advantage of one or more of the following benefits:

• Tax Deferral. You can defer your capital gains tax until you dispose of your assets or not be taxed until the end 2026. Investors can invest existing assets into Opportunity Funds. A Qualified Opportunity Fund is an investment vehicle that is set up as either a partnership or corporation for investing in eligible property that is located in a Qualified Opportunity Zone.

• Step Up. If the investor holds the QOF for at least 5 years, the original investment’s basis increases by 10%; if held at least 7 years, the basis increases by 15%.

• Exclusion. For Opportunity Fund investments held at least 10 years, investors will not need to pay taxes on capital gains.

Is Investing in An Opportunity Zone Right for You?

Opportunity Zones are economic development tools that benefit both the investor and the community invested in. As an investor, you may be considering if investing in Opportunity Zones is a good fit for you especially given the tax benefits. To learn more about Opportunity Zones, and Qualified Opportunity Funds, talk to our team at Growth 1031. Our team is a proven source of reliable information, a trustworthy ally in areas of uncertainty, and the standard bearer for client relationships. We serve clients in Los Angeles, New York City, and Chicago. Our 1031 exchange services include delayed exchanges and reverse exchanges, and we’re happy to answer any questions you may have.

Schedule your initial consultation with us today!

What is a 1031 Exchange?

1031 Exchanges get their name from Section 1031 of the IRS Code. Otherwise known as a tax-deferred exchange, this allows investors to swap an investment or business property for like-kind property of equal or greater value while deferring capital gains taxes. If your property meets the requirements, you can exchange it for another investment or property and have limited or no tax due at the time of the swap.

Discover what properties qualify for a 1031 exchange as well as a list of 1031 benefits and timelines below.

What Properties Qualify for a 1031 Exchange?

The IRS defines the following qualifications for a 1031 exchange and what “like-kind” properties mean:

Both properties must be held for use in a trade or business or for investment. Property used primarily for personal use, like a primary residence or a second home or vacation home, does not qualify for like-kind exchange treatment.

Both properties must be similar enough to qualify as "like-kind." Like-kind property is property of the same nature, character or class. Quality or grade does not matter. Most real estate will be like-kind to other real estate. For example, real property that is improved with a residential rental house is like-kind to vacant land. One exception for real estate is that property within the United States is not like-kind to property outside of the United States. Also, improvements that are conveyed without land are not of like kind to land.

The following types of properties are excluded from Section 1031:

• Inventory or stock in trade

• Stocks, bonds, or notes

• Other securities or debt

• Partnership interests

• Certificates of trust

Benefits of a 1031 Exchange

Tax Deferral

This is one of the key benefits of doing a 1031 exchange. Because you do not have to pay capital gains tax at the time of the exchange, you will have more capital to reinvest in the replacement property. 

Increased Purchasing Power

Similar to tax deferral, the increased cash flow allows you to obtain one or more properties with higher yield, compared to buying and selling a new property and paying the applicable taxes.

Wealth Accumulation

You could leverage 1031 exchanges to grow your portfolio relatively quickly, and thus increase your cash flow and net worth as you diversify. You could build wealth over the long-term and potentially pass on those investments to your heirs. 

1031 Timelines to Know

Identification 45 Day Rule

The Identification Period begins on the date the Relinquished Property closes escrow and ends at midnight on the 45th day thereafter. The Replacement Property must be identified in a signed writing, unambiguously describing the property, and must be delivered to a party

to the exchange. Identification may be made pursuant to the 3 Property Rule or the 200% rule.

The 3 Property Rule

The 3 Property Rule allows for identification of up to three U.S. properties, without regard to fair market value of the properties.

The 200% Rule

The 200% Rule allows for identification of four or more properties as long as the combined value of all properties identified does not exceed 200% of the fair market value of the Relinquished Property.

Want to Explore Your Options?

With many moving parts, 1031 exchanges can be a complex process, but it doesn’t have to be complicated. As your qualified intermediary, Growth 1031 is experienced and fully equipped to facilitate your 1031 exchanges. We walk you through all stages of the exchange and guide you through every step. Per California law, our Exchange Accommodators are also licensed and bonded for your peace of mind. Whether you want to learn more about 1031 exchanges or are ready to get into the exchange process, we’d love to hear from you! Contact Growth 1031 for a consultation today.

Disclaimer: Growth 1031, Inc. is a qualified intermediary that specializes in facilitating 1031 exchanges. Growth 1031, Inc.is not a law-firm and does not provide tax, legal or accounting advice.  You should consult your own tax, legal and accounting advisors before engaging in any transaction.

Guide to Propositions 58 & 93

Reassessment Exclusion for Real Property Transfers:

• Between parent and child

• From grandparent to grandchild

These constitutional initiatives provide property tax relief for real property transfers between parents and children and from grandparents to grandchildren. Collectively, they make it easier to keep property “in the family.”

In general, Proposition 58 states that real property transfers, from parent to child or child to parent, may be excluded from reassessment. Proposition 193 expands this tax relief to include transfers from grandparent(s) to grandchild(ren). In both cases, a claim must be filed within three years of the date of transfer to receive the full benefit of the exclusion.

For expanded definitions of Prop. 58 & 193, see Revenue and Taxation (R & T) Code Section 63.1. It is available online at leginfo.legislature.ca.gov.

---

Click on the link below to view the Printable Guide for:

• Propositions 58 & 193

• Parent-Child-Grandchild Exclusions

Get Direct Real Estate Tax Tips from the IRS On Like-Kind Exchanges

The IRS website is a great resource to learn more about like-kind exchanges. Click on the link below to learn more!

Does my primary residence qualify for a 1031 Exchange?

Learn whether your investment qualifies for a 1031 exchange.