{"id":21116,"date":"2021-03-21T17:01:43","date_gmt":"2021-03-21T22:01:43","guid":{"rendered":"https:\/\/www.rentable.co\/blog\/?p=21116"},"modified":"2022-03-28T17:03:03","modified_gmt":"2022-03-28T22:03:03","slug":"how-1031-exchanges-impact-rental-property-management","status":"publish","type":"post","link":"https:\/\/www.rentable.co\/blog\/how-1031-exchanges-impact-rental-property-management\/","title":{"rendered":"How 1031 Exchanges Impact Rental Property Management"},"content":{"rendered":"<p><span style=\"font-weight: 400;\">A 1031 exchange refers to the real estate investment practice of swapping one asset for another asset held as an investment property. 1031 refers to the United States (U.S.) Internal Revenue Code provision and is the basis for this transaction. It\u2019s also often referred to as a like-kind exchange.\u00a0<\/span><\/p>\n<p><span style=\"font-weight: 400;\">Most asset swaps would be considered sales. The seller would thus incur the corresponding capital gains taxes (CGT). But if the real estate property you swapped for another qualifies as a 1031 exchange, you might not have to pay taxes on the transaction or just pay limited taxes. You can check out <\/span><a href=\"https:\/\/www.peregrineprivatecapital.com\/\"><span style=\"font-weight: 400;\">Peregrine Private Capital<\/span><\/a><span style=\"font-weight: 400;\"> and other similar sites to learn more about how to do this.<\/span><\/p>\n<h2><b>Advantages Of 1031 Exchanges<\/b><\/h2>\n<p><img decoding=\"async\" src=\"https:\/\/cdn.pixabay.com\/photo\/2021\/01\/09\/15\/30\/house-5902665_960_720.jpg\" alt=\"House, Property, Real Estate, Mortgage, Buy, Rent\" \/><\/p>\n<p><span style=\"font-weight: 400;\">The apparent advantage of the 1031 exchange is that real estate investors don\u2019t have to pay CGT each time they swap like-kind properties. This allows them to exchange their existing asset for another one of a much higher price or value.<\/span><\/p>\n<p><span style=\"font-weight: 400;\">The long-term effect is that the investor can grow the value of their real estate investment over time because CGT doesn\u2019t have to be paid yet with each transaction. Over time, it helps Americans accumulate and grow their wealth with real estate investments. Overall, this is good for the American economy since it generates more wealth and income and creates more jobs.\u00a0<\/span><\/p>\n<p><span style=\"font-weight: 400;\">This can be enticing for those who invest in the rental property business since they can spend their money on projects that <\/span><a href=\"https:\/\/www.rentable.co\/blog\/home-upgrades-to-add-market-value\/\"><span style=\"font-weight: 400;\">add value<\/span><\/a><span style=\"font-weight: 400;\"> to their real estate property. They can make the most of whatever money they spend on their property because they\u2019d be able to exchange it later on for another one without worrying about CGT.\u00a0<\/span><\/p>\n<h2><b>What Does A 1031 Exchange Allow You To Do<\/b><\/h2>\n<p><span style=\"font-weight: 400;\">The essence of a 1031 exchange is that it allows an investor to swap an existing real estate asset for another with a higher value without having to pay for the CGT. The idea is to roll over the gain from one property to the next to grow your investment over time.\u00a0<\/span><\/p>\n<p><span style=\"font-weight: 400;\">There\u2019s no limit to the number of times you can do a 1031 swap. You can gain money each time you make a swap, and you won\u2019t have to pay the capital gain tax yet. You can do so only until you\u2019re ready to sell your real estate property for cash and no longer exchange it for a like-kind.<\/span><\/p>\n<h2><b>How 1031 Exchanges Impact Rental Property Management<\/b><\/h2>\n<p><img decoding=\"async\" src=\"https:\/\/cdn.pixabay.com\/photo\/2017\/09\/07\/08\/54\/money-2724245_960_720.jpg\" alt=\"Money, Home, Coin, Investment, Business, Finance, Bank\" \/><\/p>\n<ul>\n<li aria-level=\"1\"><b>1031 Exchanges Entice Investors To Rent Out Property<\/b><\/li>\n<\/ul>\n<p><span style=\"font-weight: 400;\">One of the most critical impacts of 1031 exchanges on rental property management is that it will entice and, in some instances, even compel investors to rent out their property. For example, owners of vacation homes would have to rent out their vacation homes to qualify for the tax deferment.\u00a0<\/span><\/p>\n<p><span style=\"font-weight: 400;\">In the past, Americans were allowed to swap one vacation home for another, and they didn\u2019t have to pay any CGT. Section 1031 exchanges allowed them to defer tax payments. They could declare their most recent vacation house as their primary residence, then invoke their 1031 exchange shield and sell their primary residence without paying CGT. But they should have lived in their primary residence for at least two years out of the last five.<\/span><\/p>\n<p><span style=\"font-weight: 400;\">The U.S. Congress closed this loophole in 2004. Vacation property owners can still do a 1031 exchange, but they should first rent out their vacation house. They would have to show proof that they rent out their vacation property for at least six months or a year before they can be allowed to do a 1031 exchange.<\/span><\/p>\n<p><span style=\"font-weight: 400;\">The apparent impact on rental property management is that owners must ensure their property has tenants before invoking a 1031 exchange. This creates business for entities or individuals who provide rental property management services. The IRS would also disqualify someone from a 1031 exchange if they rent out their property, but it doesn\u2019t get tenants.<\/span><\/p>\n<ul>\n<li aria-level=\"1\"><b>They Compel Investors To Rent Out For A Longer Time<\/b><\/li>\n<\/ul>\n<p><span style=\"font-weight: 400;\">Another impact of 1031 exchanges is that they would compel rental property investors to rent out their acquired properties for a more extended amount of time before they can invoke tax breaks. Under the new rules, an investor can\u2019t move in right away to the property obtained in a 1031 exchange.\u00a0<\/span><\/p>\n<p><span style=\"font-weight: 400;\">The IRS came up with a Safe Harbor rule in 2008. The IRS said it wouldn\u2019t challenge the status of a property as an investment property for purposes of qualifying for a 1031 exchange as long as it meets the safe harbor requirements.\u00a0<\/span><\/p>\n<ul>\n<li style=\"font-weight: 400;\" aria-level=\"1\"><span style=\"font-weight: 400;\">To meet the safe harbor requirements, investors should rent out the property to another person for at least 14 days or longer within the two 12-month periods after doing the 1031 exchange.<\/span><\/li>\n<li style=\"font-weight: 400;\" aria-level=\"1\"><span style=\"font-weight: 400;\">Investors should limit personal use of the investment property to no more than 14 days or not more than 10% of the total number of days covered by the 12-month period during which the property is rented out to third persons for an amount which can be considered as fair rent.<\/span><\/li>\n<\/ul>\n<p><span style=\"font-weight: 400;\">Another limitation is that the investor isn\u2019t allowed to immediately convert the newly acquired investment property into their primary residence. This means the investor won\u2019t be able to use the capital gain shield right away and invoke the USD$500,000 exclusion.\u00a0<\/span><\/p>\n<p><span style=\"font-weight: 400;\">Before the 2004 change, rental investors could exchange rental property for another rental property, rent it out for a time, and then move in to say it\u2019s now their primary residence. The investor could then claim exclusion of the gains from capital tax since it was a sale of a primary residence.\u00a0<\/span><\/p>\n<p><span style=\"font-weight: 400;\">But the new rule imposed in 2004 doesn\u2019t allow this scenario anymore. The investor could still do a like-kind 1031 exchange and move in to make the property their primary residence. But the investor won\u2019t be allowed to invoke the exclusion of a primary residence if the property is sold within the five years from when the 1031 exchange took place. In other words, the investor has to wait for five years to pass before the property can be sold and claim the USD$ 500,000 exclusions.<\/span><\/p>\n<p><span style=\"font-weight: 400;\">The apparent impact of this is that investors are compelled to rent out their properties for a more extended period of time. They won\u2019t be able to roll over their gains any time they want like they used to before the safe harbor and 5-year period rules took effect.<\/span><\/p>\n<ul>\n<li aria-level=\"1\"><b>Entice Investors To Make Property Improvements<\/b><\/li>\n<\/ul>\n<p><span style=\"font-weight: 400;\">A 1031 exchange operates like an incentive for property investors to spend money on improvements to their property. Under the old rules, property investors would be enticed to spend on improvements since they can keep the gain in value without having to pay CGT in the meantime when they roll over their existing property and swap it for another in a 1031 exchange.\u00a0<\/span><\/p>\n<p><span style=\"font-weight: 400;\">In rental property management, this can be an incentive for property owners to keep making property improvements with each new 1031 exchange rollover. They\u2019re enticed to invest in improvements because they know they\u2019ll get to keep their investments with each 1031 exchange, and CGT won\u2019t be deducted from their gain.\u00a0<\/span><\/p>\n<p><span style=\"font-weight: 400;\">Under the new rules, it would have quite a different impact on rental property management. Investors would now be required to rent out their property before rolling it over. The effect is that more properties would be rented out because owners would now have to wait before they qualify for a 1031 exchange. This would spur more business for rental property management and entice investors to improve on their property in the meantime.\u00a0<\/span><\/p>\n<p><span style=\"font-weight: 400;\">Another impact of the new rules is that property investors would now have to wait a little more before claiming the property as their primary residence. Investors used to do a 1031 exchange, claim the acquired property as their primary residence and then sell it to take advantage of the USD$500,000 exclusion from capital gain.\u00a0<\/span><\/p>\n<p><span style=\"font-weight: 400;\">Under the new rules, though, they\u2019d have to wait for five years before claiming it as a primary residence to avail themselves of the exclusion should they decide to sell the property. Investors would now be compelled to hold on to their properties for five more years. They would most likely be renting out such property for the next five years, thus adding to the rental property inventory in their area.\u00a0<\/span><\/p>\n<ul>\n<li aria-level=\"1\"><b>The Impact Of Gain Limitations<\/b><\/li>\n<\/ul>\n<p><span style=\"font-weight: 400;\">The proposed changes to the <\/span><a href=\"https:\/\/www.investopedia.com\/financial-edge\/0110\/10-things-to-know-about-1031-exchanges.aspx\"><span style=\"font-weight: 400;\">1031 exchange<\/span><\/a><span style=\"font-weight: 400;\"> rules have also set a cap of USD$500,000 on all gains from the exchanged property. Any gain over USD$500,000 would now incur CGT under the proposed new rules. Investors would now make sure they don\u2019t invest money in improvements, leading to gains above what they could shield under the exclusions.\u00a0<\/span><\/p>\n<p><span style=\"font-weight: 400;\">This would also impact rental property management since there would now be less investment in property improvements. Overall, this would result in a decline in the construction quality of rental properties since there\u2019s less incentive to invest in property improvements. They would most likely invest only in improvements to the extent that they could keep the gains under the exclusions.<\/span><\/p>\n<h2><b>Conclusion<\/b><\/h2>\n<p><span style=\"font-weight: 400;\">A 1031 exchange isn\u2019t exempt from the payment of taxes. Payment is just deferred until such a time that the property is actually sold and transferred by the investor in a transaction which isn\u2019t a 1031 exchange. In a 1031 exchange, the gain in value wouldn\u2019t incur any taxes and can be paid towards the final price of the new property. Under the proposed rules, though, there\u2019s now a USD$500,000 cap on gains.<\/span><\/p>\n","protected":false},"excerpt":{"rendered":"<p>A 1031 exchange refers to the real estate investment practice of swapping one asset for another asset held as an investment property. 1031 refers to the United States (U.S.) Internal Revenue Code provision and is &#8230; <\/p>\n<p class=\"read-more-container\"><a title=\"How 1031 Exchanges Impact Rental Property Management\" class=\"read-more button\" href=\"https:\/\/www.rentable.co\/blog\/how-1031-exchanges-impact-rental-property-management\/#more-21116\" aria-label=\"More on How 1031 Exchanges Impact Rental Property Management\">Read more<\/a><\/p>\n","protected":false},"author":23,"featured_media":19237,"comment_status":"closed","ping_status":"closed","sticky":false,"template":"","format":"standard","meta":[],"categories":[473],"tags":[],"_links":{"self":[{"href":"https:\/\/www.rentable.co\/blog\/wp-json\/wp\/v2\/posts\/21116"}],"collection":[{"href":"https:\/\/www.rentable.co\/blog\/wp-json\/wp\/v2\/posts"}],"about":[{"href":"https:\/\/www.rentable.co\/blog\/wp-json\/wp\/v2\/types\/post"}],"author":[{"embeddable":true,"href":"https:\/\/www.rentable.co\/blog\/wp-json\/wp\/v2\/users\/23"}],"replies":[{"embeddable":true,"href":"https:\/\/www.rentable.co\/blog\/wp-json\/wp\/v2\/comments?post=21116"}],"version-history":[{"count":1,"href":"https:\/\/www.rentable.co\/blog\/wp-json\/wp\/v2\/posts\/21116\/revisions"}],"predecessor-version":[{"id":21117,"href":"https:\/\/www.rentable.co\/blog\/wp-json\/wp\/v2\/posts\/21116\/revisions\/21117"}],"wp:featuredmedia":[{"embeddable":true,"href":"https:\/\/www.rentable.co\/blog\/wp-json\/wp\/v2\/media\/19237"}],"wp:attachment":[{"href":"https:\/\/www.rentable.co\/blog\/wp-json\/wp\/v2\/media?parent=21116"}],"wp:term":[{"taxonomy":"category","embeddable":true,"href":"https:\/\/www.rentable.co\/blog\/wp-json\/wp\/v2\/categories?post=21116"},{"taxonomy":"post_tag","embeddable":true,"href":"https:\/\/www.rentable.co\/blog\/wp-json\/wp\/v2\/tags?post=21116"}],"curies":[{"name":"wp","href":"https:\/\/api.w.org\/{rel}","templated":true}]}}