Real estate offers plenty of strategies to avoid taxes. However, many require you to jump through hoops, hire third parties to help you, and otherwise make your life harder.
This is why I use the “lazy 1031 exchange” strategy: no hoops, no hassles, no hiring custodians.
But before explaining what a “lazy 1031” is, let’s make sure we’re all on the same page about how standard 1031 exchanges work.
Refresher: 1031 Exchanges
Section 1031 of the IRS tax code allows investors to do a “like-kind exchange,” swapping one similar asset for another. When you sell a rental property and use the proceeds to buy another, you defer capital gains taxes on the sold property.
Using 1031 exchanges, you can buy increasingly larger, better-cash-flowing properties without ever paying capital gains taxes on any of the profits. Actually, you have to trade up: The new property must have a greater value than the sold property.
Of course, you have to pay the piper eventually. When you sell the last property in the chain, you owe full capital gains taxes on all accrued profits. Or you could just hold it until you die and let the cost basis reset. But I digress.
That all sounds great in theory, but 1031 exchanges come with drawbacks and headaches. To begin with, you have to comply with strict timelines. Within 45 days of selling the old property, you have to declare the new one you intend to buy as a replacement. And you have to actually settle on it within 180 days of selling the last property.
You also need to hire a “qualified intermediary” to hold your proceeds from the prior property sale. It costs hundreds of dollars, perhaps more, even if you use your bank as the qualified intermediary.
Don’t get me wrong—1031 exchanges work. They help you avoid capital gains taxes when selling income properties. But they also come with red tape—and in most cases, they’re only practical to use with active real estate…