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The 1031 Exchange and the Self-Directed IRA – Episode 202

1031 Exchange

IRA Financial’s Adam Bergman discusses the similarities of the 1031 Exchange and the Self-Directed IRA, and how you can benefit.


In this podcast, Mr. Bergman explains what a 1031 exchange is and how it works. He also discusses how the Self-Directed IRA works and how it is similar to the 1031. Here’s a hint – it’s all about taxes, specifically, not needing to pay them right away! Without further adieu, here’s a breakdown of what Mr. Bergman talks about.

What is a 1031 Exchange?

A 1031 exchange, also known as a “like-kind” exchange is essentially a trade of one investment property for another. Instead of paying the taxes on the gain of the sale, you defer the taxes by purchasing another piece of property. For example, you sell your property for $50,000 more than you bought it for. Without the 1031 exchange, you would have to pay taxes on that money. Instead, assuming you follow the rules of the exchange, the taxes are deferred until you sell a property without buying another.

The “like-kind” aspect may be a little misleading. You can only do a 1031 exchange with real estate. Therefore, you can exchange a rental house for raw land or an apartment building for a commercial space. Essentially, the only type of property you cannot use a 1031 on is your primary residence. Therefore, you can’t sell the house you reside in, and exchange it for another. You will have to pay taxes in this instance.

Rules of the 1031 Exchange

Since it’s very rare that two people, with two pieces of property, would be a perfect match for an exchange, there must be a middleman. This person, known as a “qualified intermediary,” will be your money person. When you sell your property, he or she will hold on to that cash. He/She will then use those funds to buy your new investment property.

Also, the timing of the two transactions is very important. Assuming you are using an intermediary, you have 45 days from the sale of the property to let him or her know of the property you intend to purchase. As per the IRS, you may choose three properties, so long as you close on one.

Secondly, you have 180 days from the sale of the property to close on the new one. To be clear, once the sale of the original property is finalized, both of these time-frames start counting down. Therefore, if it takes 30 days to identify a property, you only have 150 days to close on it.

Of course, there are other rules including mortgages/loans, depreciation recapture, vacation home exchanges. Check out this Investopedia article for more information about that.

How Does the Self-Directed IRA Compare?

An Individual Retirement Account, or IRA, is a tax-advantaged account that lets you save for retirement. Just like a 1031 exchange, you can buy and sell real estate if you have the right IRA. Essentially, you need a Self-Directed IRA to invest in alternative assets, specifically, real estate. A 1031 offers the same benefits of the Self-Directed IRA for properties you hold personally (i.e. outside of your retirement account).

As Mr. Bergman refers to it, tax-deferral (along with compounding) is the 8th Wonder of the World. This can be attributed to great minds like Albert Einstein and Warren Buffett. All taxes in traditional retirement plans are tax-deferred. Therefore, all gains and profits from your investments are not taxed until you withdraw during retirement. Similarly, a 1031 exchange defers the taxes on the gains from the sale of your investment property. The major difference is that you can only buy and sell real estate with a 1031. If you have a Self-Directed IRA, not only can you invest in real estate, but you can invest in precious metals, tax liens, stocks, bonds and mutual funds. The list is nearly endless, with the right custodian.

Further, if you have a Self-Directed Roth IRA, you pay no taxes on your qualified withdrawals. This is because a Roth is funded with after-tax dollars. There is no immediate tax break, but so long as the account has been open for five years and you are at least age 59 1/2, you receive tax-free distributions.

Many experts, including Mr. Bergman, believe the Roth IRA is the best way to invest. Pay the IRS before you contribute to the plan, and never have to worry about taxes again. Imagine your $50,000 in contributions through the years grew to over $1 million. That money will never be taxed!

Which is Better?

All things being equal, the Self-Directed IRA (specifically the Roth option) is the far superior choice. A 1031 exchange is a great tax strategy for real estate held with personal funds. But, that’s it. You can’t one day decide you want to move from real estate investing to another asset class and reap the benefits of the 1031. However, there are no such limitations with a Self-Directed IRA. Again, assuming your plan allows for it, you can invest in just about any asset class you want with your IRA funds. Moreover, there are no time restrictions either. You are not forced to buy a new property immediately. So long as the funds from the sale of an IRA-owned property remain in the IRA, you can do whatever you like with them.

Obviously, Self-Directed IRAs have their own set of rules. You must work with an experienced IRA provider and it’s highly recommended to work with a financial planner. Together, you can come up with an investment plan that works for you.

Thanks for Listening!

As always, thanks for listening to our podcast about the 1031 exchange. Remember you can listen to all of our older podcasts on our SoundCloud page! If you have questions about the 1031 or anything else, please contact us @ 800.472.0646!


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