Consolidation and Diversification of Investments through 1031 Exchanges

Code section 1031 has long since been the best kept secret of savvy real estate investor who are buying and selling investment properties. Today, this extremely advantageous tax benefit is used by beginners as well as the most seasoned real estate investors alike. Section 1031 of the Internal Revenue Code allows the taxpayer to defer capital gains tax on all property held for trade, business or investment. Furthermore, Section 1031 allows a real estate investor to defer capital gains taxes due on an otherwise taxable sale of appreciated real estate when that investment property is replaced with a "like-kind" investment property.

Consolidation and Diversification through 1031 Exchanges
A 1031 Exchange is a useful tool to either consolidate or diversify a real estate portfolio. In a consolidation exchange, the investor holds two or more investments and decides that the investments have become too unwieldy to manage. Through a consolidation 1031 exchange, an investor can sell his multiple investment properties and "consolidate" them into one investment property, or merely a smaller number of properties, thus making the investment properties much easier to manage. 

A diversification exchange is the opposite of a consolidation exchange. In this instance, the investor has one or a small number of large investment properties. The investor may feel that his real estate portfolio is too concentrated in a particular market. The investor can sell the properties within the concentrated market and "diversify" them into a large number of properties in other markets.

Advantages of Using 1031 Exchanges in Consolidating or Diversifying Investments

A 1031 Exchange is a superior tool for consolidation and diversification of investment properties due to its tax deferring nature. Using a 1031 exchange to consolidate or diversify a real estate investment portfolio enables the investor to meet his investment objectives and risk tolerances. In addition, an investor can completely reorganize his or her investment portfolio without having to pay one cent of tax to the IRS until the ultimate disposition of the investment properties.

Disadvantages of Using 1031 Exchanges in Consolidating or Diversifying Investments

There is only one disadvantage to using 1031 Exchanges to consolidate or diversify investment properties, but the disadvantage is easily mitigated through planning. The 45-day Rule and the 180-day Rule are time limits placed on 1031 Exchanges by the IRS. There is a 45 day limit within which to identify replacement property and a 180 day limit within which to finish all of the exchanges. This gives, for instance, the investor who is diversifying a small number of investment properties into a larger number of investment properties a small window within which to identify the larger number of properties. Obviously, the larger the number of desired investment properties sought by the diversifying investor, the more difficult it is to comply with the 45-day Rule. Such time constraints may be avoided, however, by simply identifying the larger number of replacement investment properties prior to engaging in a 1031 Exchange. Such a procedure is called a reverse exchange. A straddle exchange is another method for alleviating the time constraints of the 45-day Rule and the 180-day Rule. Both reverse exchanges and straddle exchanges lie outside the confines of this topic, however. Both procedures are common and completely valid under the IRS Code Section 1031. If you have any questions concerning either one of these two procedures, please call us at 1-800-331-1031 and any of our consultants would be happy to explain these exchanges to you in greater detail and free of charge.

Conclusion

Any investor seeking to either consolidate or diversify his or her investment portfolio, but does not want to face excessive tax liabilities, would be well suited to consider using a 1031 exchange. With proper planning and consultation, these types of exchanges can be structured in order to meet an investor's specific investment objectives as it applies to his or her real estate portfolio.