After about three years in the business, I realized two things: one, taxes were a big part of real estate and two, real estate is one of the most tax advantaged investments in the world. When you start dealing in high value assets, like stocks, bonds, precious metals, and real estate, you’re going to come across something called a capital gains tax. A capital gains tax is the tax the government puts on the profits you make from the sale of any one of these non-inventory assets. The higher value of the asset, the higher price of the tax penalty, right? For one thing, capital gains taxes vary from 0%-20% depending on your taxable income bracket, but if you make more than $50K annually, you’re going to end up paying something.
While paying taxes is part of being a member of a community, at a certain tipping point the tax paid works against the actual value of the asset in question, in this case, real estate. When we speak about creating generational wealth and making investments with longevity, we want that number to increase, not decrease or be otherwise compromised. For example, if your children were to inherit your property when you die and sell it, they’ll pay capital gains taxes on the sale and will thereby be inheriting less monetary value than you thoughtfully put together for future generations. So, how do we defer these taxes and protect your assets?
Understanding taxes associated with real estate is the second most important thing you’ll want to learn when it comes to your investment. Now, I’m going to let you in on a secret a few people know about: when you buy real estate and sell it, if you buy another property, you fall in line with Internal Revenue Code 1031 and therefore don’t pay any capital gains tax. Period. Provided, this only applies if the secondary piece of real estate you buy isn’t your primary residence, but if the intention behind making your investments in real estate is to accrue generational wealth, buying property other than your primary residence is something that’s already in your economic vocabulary. So long as you retain this information and act on it, you can do this for the rest of your life. Just be sure to spread the knowledge to whoever’s inheriting your estate so that the value of your property remains at market value and your heirs pay no capital gains.
Internal Revenue Code 1031 is applied on the federal capital gains tax, so depending on which state you live in, you may end up paying some tax over all. But, this secret amongst investors is one that should be shared. You may hear it referred to as the Starker Exchange or the Starker Loophole. This turn of phrase refers to a 1979 court case wherein the ruling concluded that an agreement to exchange property of like-kind is essentially the same as a lateral transfer of funds. To rephrase: if the capital gains tax on the property you sold is going to inevitably be of approximately the same value as the secondary property you purchase after the sale, there’s no immediate need to pay capital gains tax on the sale. And to put it even more simply: the federal court also agrees it’s an okay thing to kick the proverbial can of capital gains tax down the road so long as everyone stays informed and no one drops the ball.
You already know that purchasing real estate outside of personal use is a smart investment, but given the tax incentive to continue down this path, it’s almost a no-brainer to keep the ball rolling. Furthermore, one of the primary keys to generational wealth is the sharing of information. First, you have to accrue the wealth in question, but what keeps your capital in a state of growth is ensuring that these “secrets” – which are only bits of knowledge shared between parties on a need-to-know basis – are communicated effectively is crucial in protecting the value of your financial estate.
Like the saying goes, knowledge is power. And now you know.