Did you know that real estate investors can save tens of thousands by using advanced tax strategies for real estate investors to enhance their business? While properties may be the backbone of your portfolio, taxes are still a concern. With increased pressure on the median wage, saving money on your tax bill is essential for your personal finances and your portfolio. People invest in real estate because they want to make money - and we're here to help make those investments work even harder for you!

There's no better way to start than with this comprehensive FAQ list.

1.What is the purpose of Section 1031 Exchange?

According to the IRS, Section 1031 provides for tax-free exchanges of real property held for productive use in a trade or business or for investment. This means that you don't have to pay taxes on any income that's generated from the acquired property. It's essentially a deferral, rather than a complete exemption. You're exchanging one property for another, so it's still considered productive activity. Similar deferred exchanges are also available under Sections 1033 &1035 – they can be used by individuals or businesses when they want to use their capital gains taxes to obtain another income-producing asset.

2.What are the advantages of using Section 1031?

Section 1031 is a deferral, meaning you don't pay taxes on any income or gains until you sell your property and the proceeds from the sale. By deferring taxes on your sale (pending the sale), you can greatly reduce your tax burden when selling. For example, if you have $1 million worth of real estate in your portfolio, and you wanted to avoid paying capital gains taxes on $50,000 – a maximum of 40% - what would happen? It turns out that this would only create a taxable gain of $3,000 ($50k x 40%). However, if you hold onto the property and exchange it at a later date, you'll be able to defer your taxes on all of those gains, potentially creating a taxable gain of $7,000 ($1 million x 30%).

3.Are there disadvantages to using Section 1031?

While this is an incredible way to reduce capital gains tax, there are some important downsides. Basically, this strategy only works when the value of the property you're selling is greater than the amount of your initial investment (plus any appreciation since). For example, let's say that I have $1 million in real estate and I once paid $500k for that same property. If I were to sell it for $1.5 million, I would only have a taxable gain of $500k ($1m-$500k-$0). So, even though the property had appreciated in value by $500k since you purchased it, there would be no taxable gain on your end. Essentially, you could defer the taxes on all of that appreciation.

4.How can real estate investors benefit from this?

In a nutshell, real estate investors can benefit from this strategy when purchasing their next properties. If you have a lot of cash on hand and something you want to buy, this will likely eliminate the need to pay taxes out-of-pocket before you close on the property. If you're needing money for your business – whether it's for your down payment, to purchase a new piece of real estate, or to fund some other type of project – this strategy may be ideal. You can defer income that would have otherwise been produced until later on in the sale process.

5.How does the exchange work?

So let's say early in my real estate investing career I want to sell my $1 million home and I'm trying to maximize my capital gains tax savings. I could simply sell the property and pay taxes on it. However, if we look at my real estate portfolio, with all of those properties – each of which I've already paid taxes on – I won't be able to defer income from any single one in this example. So, I'd have a taxable gain of $1 million ($1m - $500k) and would pay taxes out-of-pocket for that de minimis gain.

6.How do I know whether a particular repair should be classified as an expense or capital item?

In general, capital improvements are considered "productive economic activity" which reduces the number of your taxable gains that you can defer. That said, your accountant will need to explain why a particular repair is or is not productive economic activity. For example, if you're in a new condo in an area that's been hit by recent floods and there's mold everywhere - for which you've already paid taxes - then your accountant may recommend that those repairs be deferred. However, if the cost of the repairs doesn't exceed $5k and doesn't constitute a capital improvement – for example, if it's an appliance – then it's likely acceptable to defer.

7. Is Section 1031 a form of real estate investment?

Using Section 1031 isn't a form of real estate investment, but the process of purchasing and selling properties can be. For your purposes, you may have four or five investments on your plate that you're trying to sell. For example, let's say that you own five different properties in different areas – and they're all appreciated by 50%. You could then sell one property for $20k, purchase a new one for $10k with $10k in cash, then exchange the purchased property and purchase another new one with that same tax-advantaged money. This doesn't change your portfolio's value overall because it would just be creating an exchange.

8.What are some ways to pay fewer taxes when using Section 1031?

When using Section 1031 for your real estate investments, you will want to purchase an exchange-listed property during the 180 days before or after the sale of your old real estate. This could include some types of short-term leases, though it's best to seek out properties that aren't considered "income-producing" (like all-cash tenants) or properties that you don't have any plans on renting out yourself (like a second home). The same concept goes for short sales – if you're planning on exchanging properties within the next 180 days, it's best to look for a seller who wants to complete a short sale rather than a foreclosure.

9.What are some alternatives to Section 1031?

There are also different ways to maximize the use of your capital gains without using 1031. For example, if you're planning on selling a property during the next year or two, you may want to sell it and pay taxes on that gain right away. It might be more beneficial for you to keep the asset, though. For example, if you plan on making investments in other real estate properties, you could continue holding onto that property until that time comes and then exchange it like normal.

10.How can I get more in-depth information on Section 1031?

If you'd like to learn more about Section 1031, you can reach out to your accountant. They should be able to give you a better estimate of how much capital gains taxes you're likely to pay in the future and help you decide whether this strategy is right for you. Make sure to ask your CPA if there are any additional fees associated with using Section 1031 beyond the fees that would be associated with buying a property (for example, closing costs). Find an accountant near you here: www.cax4biz.com.

11.What are the benefits of using Section 1031?

So what are some of the benefits of Section 1031? Some of the things you could do include: reducing your capital gains taxes, curbing your tax burden, deferring loss from a property, receiving discounted interest rates on your tax-advantaged money, and avoiding all capital gains taxes for a period of time. Additionally, by using Section 1031 you will also be able to defer income that will be produced by future properties. Some people may find that this is more cost-effective than paying taxes out-of-pocket. So it might be a smart choice if you're trying to acquire a new property and need money for a down payment or to fund another real estate project.

12.What is the main disadvantage of Section 1031?

The main disadvantage of using Section 1031 is that you must have control over the property. Additionally, it's not always possible to find a buyer for your property that will agree to use the Section as well. It's also important to note that if you hold onto one set of properties for over 180 days – without selling them or trading them – then you will still be required to pay taxes on any gains that were produced from those properties up until that point.

13.Can I defer capital gains taxes for more than one property?

Yes. If you have more than one investment property, then you can use Section 1031 to defer capital gains taxes. However, the properties that you trade for must be of equal or greater value to the property that you're selling. For example, if you sell a $500k property and buy a $650k property with the money, then it would be possible to defer all of your taxable gain using Section 1031. Likewise, if you sell a $500k property and buy a $500k property with the money, then most of your capital gains would not be deferred using this strategy – even though it's still possible to do so in some cases.

14.Are there any limits on Section 1031?

There are no limits on the number of times that you can use Section 1031. With this strategy, you are not required to exchange properties within a certain timeframe or at any particular time. You are allowed to defer capital gains taxes in both taxable and tax-advantaged assets. However, if you plan on trading one set of properties back and forth, then you might want to consider using the delayed exchange strategy (which is not related to the use of Section 1031). It's important for you to know what’s possible with your goal properties when it comes time for your next transaction.

15.What are some tips for planning around Section 1031?

When using Section 1031, it's important that you plan your property exchanges strategically. If you plan on trading one set of properties back and forth – without selling the properties, then it would be beneficial to use a delayed exchange strategy. It allows you to defer capital gains taxes even if the property that you originally sold was not worth as much as the property that you're buying. Over a period of time, this strategy can save enough money to make your initial investment worthwhile.

16.Can I use Section 1031 to defer capital gains taxes for my overall portfolio or as tax strategies for real estate investors?

Yes. Section 1031 allows you to defer capital gains taxes for an entire portfolio of investment properties. However, it's important to know that you can only defer gains within the same asset class. For example, if you have a depreciable tangible property in addition to investment real estate, then it would not be possible to use both Section 1031 and the IRS 1031 exchange rules at the same time – since they are very different sections. On the other hand, if your portfolio consists of only tax-advantaged investments (such as REITs), then you could use both Section 1031 and IRS Form 8824 quite easily.

17.How does Section 1031 affect my ability to deduct losses?

You may be wondering, do I get to deduct any losses on Section 1031 exchanges? The answer is yes. You can use your losses to reduce the amount of income that you paid in taxes on the gain. If you're using a deferred exchange with a like-kind property, then you will either take a reduced basis in the new property or claim an ordinary loss if your basis in the old property is higher than its value at the time of exchange. If you're using a simultaneous exchange, then there's no reduction in your tax basis for purposes of claiming an ordinary loss.

For more information, you can visit Real Estate Calculators.