Don’t Let Taxes Stop You From Diversifying Your Real Estate Portfolio
Equity investors are encouraged to diversify their stock holdings because subjecting your
hard-earned investment in one holding subjects it to the fickle finger of the market. As Cervantes wrote, “Don’t hold all your eggs in one basket.” This rule also applies to real estate. While many real estate investors tend to acquire property in areas close to where they actually live due to familiarity or perceived cost-savings, it is often valuable to diversify your real estate holdings into separate regions so a drop in property value in one area will not disproportionately affect your wealth. Many real estate investors are not opposed to investing in other regions, but they are concerned about the taxes that need to pay when they sell some of their holdings to free up the cash to purchase new property. PMG Intrinsic is here to help you with a 1031 Exchange that will allow you to defer taxes while helping you diversify your real estate portfolio.
Even with the Covid-19 pandemic, prices for real estate have been surprisingly resilient. Zillow has reported that that every day since March 31, web traffic for Los Angeles has been higher than the previous year. PMG Intrinsic has counseled many of its clients that they should exchange properties in a tax-advantaged manner in expensive markets, for cash-flowing property in comparably inexpensive markets.
A 1031 Exchange allows an investor to defer capital gains taxes on the investment property when it is sold. In order to take advantage of this powerful tax strategy, the seller must also acquire investment or business property that is of equal or greater value. For example, a client may sell a property for $1 million with a $500,000 loan in Los Angeles. The same client will need to identify replacement property 45-days after the sale of the initial property, and then close on the replacement property 180-days after. If the value of the replacement property is greater than $1.5 million, then the client defers all gain on the sale of the initial property. However, if the value of the replacement property is less than $1.5 million, then the client will need to pay capital gains on the difference, which is referred to as a “boot”.
PMG Intrinsic successfully counseled a client who held one piece of valuable investment property in Los Angeles worth $2.5 million that he wanted to sell because it would take much additional capital to renovate and keep up-to-code.
The client purchased the property in 2004 for $1.2 million. As a result, even though the building was not up-to-code, he would have been responsible for capital gains on $1.3 million! This would have been taxed at a combined state and federal capital gains rate in excess of 35%! However, the client was also interested in 10 beautiful condos in Detroit and Dallas that were worth a total of $2.6 million and generating monthly free-cash flow in excess of $41,000. With PMG Intrinsic’s counsel, not only did the client defer his capital gains, he improved the diversification of his holdings by spreading its exposure to different regions in the county and also improved his cash-flow.
A 1031 Exchange is extremely valuable for real estate investors, but the rules are very technical. A small mistake can jeopardize the deferment of capital gains, and possibly ruin a diversification strategy. It is crucial that you seek a professional firm like PMG Intrinsic to help guide you and strengthen your real estate portfolio.