Avoid Taxes Like The Pros

I ran in the Zilker Relays race for the first time.  It's an awesome team race where you each run a leg around Zilker Park while listening to live music and eating tacos.  I love living in Austin :)

I just completed the first part of what's called a tax-free exchange (also known as a 1031).  If you own investment real estate and have no idea what I'm talking about, read on.

Imagine you have an investment home and you bought it more than a few years ago - it’s gone up a lot in value. If you sell it/cash out, you'd have a profit on that home and pay capital gains tax (15-20% depending on your tax bracket).

But paying taxes sucks.  It’s the single biggest expense most of us have.

Now, most people that invest in real estate, what they'll often do is trade their real estate into something else. In this case if you have profits you might sell the property and use the (now larger) equity as a down payment on a bigger property.  For example - you bought a $300k home and put $75k down.  It’s gone up to $400k, so now you have ~ $175k in equity.  You sell the original home and put that $175k down on a $700k home.  You just traded your $300k home in for a $700k home with no extra money out of pocket.

Here’s one more example of why you might want to do this.  You bought a rental home for $200k cash.  Now it’s worth $400k.  Your net cash flow after expenses is ~ $800/mo.  What if you decided you wanted more cash flow?  You could take that $400k house, sell it, and use that as a down payment to buy a $1.3mm commercial property.  You’d be getting a loan this time around, but your net cashflow would more than double, again, with no extra cash out of pocket.

See how this could be beneficial?  If you don’t do the tax free exchange, you’d be paying ~ $20k in taxes on the first example, and $40k on the second example.  That’s a huuuuge drag on your investments.