Real estate investors generally agree that taxes are their biggest enemies in most cases when they want to buy or sale properties. However, there are some strategies that can actually allow them to defer certain taxes, thus leaving them with money more to invest in other purposes. It is important for investors, especially beginner ones, to have some knowledge on the real estate investment strategies that can guarantee them tax deferral. Here are three of the best strategies related to this topic.
The 1031 exchange strategy
The 1031 exchange strategy is one of the best methods in which real estate investors can defer taxes. It implies that a property, whether it is held for rental, used in businesses or for investment, can be exchanged for another property on the condition that the replacement property is similar to the relinquished one and equal in terms of value. The greatest advantage that this strategy comes with is that it offers the investor the possibility to defer federal and state income tax liabilities. Keep in mind that this allows you to defer taxes and does not mean they are completely eliminated, as many people misunderstand. There are certain rules and regulations that must be met when exchanging properties with the 1031 strategy and probably the most challenging one is to find a replacement property within the first 45 days from the moment you singed the sale contract.
The 1033 strategy
This strategy implies that an investor can exchange a property that is the subject of destruction by an act of God (for example hurricane, fire, earthquake or any other natural disaster) or of an involuntary or compulsory conversion from a condemnation by federal, state or local government to another “like-kind” property, on the condition that the latter one is either related in service or similar to the former one, which was involuntarily converted. In case of natural disasters, property owners have a two-year period during which they can replace it, and in case of eminent domain proceedings, they have up to three years.
The 721 strategy
Last but not least, the 721 exchange strategy is another way in which investors can defer taxes. This one implies that an investor can exchange a real estate that is currently being used in either investment or rental purposes for shares in a REIT (Real Estate Investment Trust). This is also known as the 1031/721 exchange or upREIT, because investors who usually resort to this strategy use both the upREIT and the 1031 exchange at the same time in order to sell relinquished properties and to purchase replacement ones. The replacement property is held for a period of at least 12 months for rental or investment purposes and then it is contributed into a REIT in exchange for shares of stock utilizing the 721 strategy.
All in all, these are three of the most popular real estate investment strategies that allow investors to defer taxes and benefit from more money that they can use in various other purposes.