A 1031 exchange allows taxpayers to defer taxable gains on exchanges of like-kind assets, such as property for property. Because IRA earnings already carry tax benefits, retirement account holders rarely need to employ a 1031 exchange.
However, some IRAs may earn taxable income (and taxes) when holding assets purchased with debt financing. In this case, an IRA owner may want to utilize the 1031 rules and exchange a debt-financed property for another. The result of this exchange is that all or most of the IRA income taxes are deferred.
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How Does a 1031 Exchange Work?
Debt financing allows an IRA to borrow money to purchase property so that the IRA can have more buying power and thus purchase a pricier property or more properties in general. For example, with debt leverage, an IRA with $100,000 can have the buying power of $300,000 or more. Leverage is seldom available with securities investments in IRAs, which is why self-directed IRAs provide so many benefits for retirement investors.
To engage in a 1031 exchange, real estate IRA owners will need to utilize a qualified intermediary. Once the sale of your property is complete, the qualified intermediary will receive the cash. The IRA cannot receive the cash or else it will not count as a 1031 exchange to tax courts.
1031 exchanges must also be performed in a timely manner. You must close on the new property within 180 days of the sale of the old property. Within 45 days of the sale, the IRA holder must designate a replacement property in writing to the qualified intermediary.
Many of our clients believe that investing in a cash-flowing real estate property with funds they have available in their IRA maximizes the value of their account. Consequentially, these clients select real estate as an asset after being unsuccessful with more common (yet potentially volatile) retirement investments like stocks and bonds. Self-directed IRAs allow account holders to make their own investment choices by utilizing their personal knowledge and experience within the real estate market.
Do Your Homework
Like all investments, due diligence can help you decide what will work best for your IRA and its investments. New Direction Trust Company can help with the administration and bookkeeping of your IRA and will review your upcoming transactions.
Send us a secure message through your Client Portal or give us a call at 877-742-1270 with any questions or concerns.