If you are a business owner who is thinking about selling your business or property in a few years, then you need to know this.
Why are so many landowners reluctant to sell their properties?
Because they have to pay capital gains tax, along with depreciation recapture tax.
This decreases your cash flow and will punish you for liquidating your asset.
So what can you do?
The solution to this is the 1031 Exchange
But what is the 1031 Exchange and why does it matter to you, the business owner?
A 1031 Exchange helps you defer taxes and increase cash flow by replacing a property that is not generating cash for one that is. It must be a like-kind property like raw land for an apartment building, farmland for an office property, industrial for raw land, and shopping center for an investment condo.
How does it work? You swap your property for another one.
Other benefits for business owners that come from doing a 1031 exchange are :
- You will be able to relocate or expand your business
- You will be able to increase efficiency and profitability by acquiring a new facility
- You will be able to free up capital by capitalizing on increased depreciation opportunities and diversifying your business
Let’s give you an example:
Sell a building that has a large capital gain.
You paid $1,000,000 for the building and now that building is worth $2,000,000.
You have a few options. One is to pay taxes on your gain of $1,000,000 which would mean sending a check of $238,000 with a capital gains rate of 23.8%
The other option is to defer your taxes. If you do a 1031 exchange then your tax liability on that sale would be $0 and you would continue to defer therefore increasing the power of compounding growth potentially forever. Kids get step-up in cost basis then taxes are never owed on this…..
If you defer taxes by doing a 1031 exchange, let’s assume that you are in the highest tax bracket, and keep $2,000,000 at 7% for 20 years, you will end up having $7,739,368. On the other hand, if you don’t do the 1031 exchange and pay $238,000 in taxes, you will be able to invest $1,762,000 at 7%. In 20 years you will have $6,818,384. In summary, doing a 1031 exchange will help you earn 920,984 in the long term….
One of the common questions about 1031 exchanges is: What happens when this land is inherited to my children? Will they have to pay for taxes on capital gains over time?
As long as you keep implementing the 1031 exchange until you pass away, your heirs won’t have to worry about taxes from all your capital gains. The cost basis will reset when you pass away.
As you can see, the 1031 exchange is great to defer taxes and also benefit your business and your finances long term. It is actually the most important tax strategy to help you preserve and grow the value of your real estate investment.