Investing in real estate can assist you in diversifying your investment portfolio by adding physical assets and providing you with a hedge against inflation. If you are a real estate investor, or if you aspire to become one, you will want to know about like-kind exchanges because they give you a chance to shift your real estate investments on a tax-deferred basis.
Like-kind exchanges give you the opportunity to have a dynamic real estate portfolio that you can adjust based on the market and the economic conditions without incurring a large tax liability. Here is how they work.
If you’re looking for counsel on diversifying your portfolio or adding physical assets to your holdings, consider working with a financial advisor.
Like-Kind Exchange, Definition
A like-kind exchange happens when an investor wants to sell real estate and avoid the capital gains tax that would normally be assessed. The investor can use the like-kind exchange to sell a parcel of real estate and buy another parcel as long as the parcel they buy is similar to the parcel they sell. A like-kind exchange is authorized as a Section 1031 exchange under the Internal Revenue Code (IRC). Both the like-kind exchange and like-kind property are defined under Section 1031.
Like-kind property is composed of real estate assets that are so similar in nature that they qualify for a like-kind exchange. The Internal Revenue Code defines a like-kind property as any held for investment, trade, or business purposes under Section 1031. Grade of the assets or quality of the assets is not used to determine like-kind property. Personal property cannot be used in a like-kind exchange. The gains of the transaction are not tax-exempt. They are tax deferred.
Section 1031 of the IRS Code exempts the seller of the property from paying capital gains as long as the property is for business and investment purposes. The seller must purchase like-kind property every time they sell property in order to defer taxes for the longest time period possible.
Like-Kind Exchange, Types
There are four types of like-kind exchanges:
- Simultaneous: The simultaneous exchange is reasonably simple. It is the simultaneous exchange of one qualifying property for another with the transaction closing that day.
- Deferred: The deferred exchange may be the most common. The seller sells the property and has 45 days to identify the property that will be exchanged for it. Then, the seller has 180 days to complete the sale. An exchange facility is often used to facilitate the deferred exchange to be sure it doesn’t become a taxable event.
- Reverse: A reverse exchange occurs when the property that will be the replacement property is acquired, and the seller has 180 days to sell the original property.
- Improvement: An improvement exchange requires that the property that is acquired be placed with an intermediary for 180 days while construction or improvement occurs.
Like-Kind Exchange, Conditions & Rules
Several conditions must be met for a property to qualify for an exchange. The property must be used in a trade, business or investment. Personal property does not qualify. The property must be like-kind to the property it is replacing. Usually, real estate is like-kind to other real estates as long as neither parcel is for personal use. Using an exchange facility for the transaction helps ensure that a mistake is not made regarding the personal property issue.
There are also a set of rules that must be followed when doing an like-kind exchange:
- When the replacement property is finally sold, that’s when the tax on the capital gain is paid.
- Only business or investment property can be exchanged as of the enactment of the Tax and Jobs Act of 2017.
- The exchange must be identical in nature.
- The replacement property must be of the same or higher in value.
- The owner of the original and replacement property must be the same person.
- The property must be acquired in 45 days and the transaction closed in 180 days.
The Bottom Line
Real estate investors, dealing in frequent real estate transactions, should take advantage of like-kind exchanges when they can. Since real estate is usually like-kind for other real estates, the rules may not be as hard to follow as it appears. The most difficult issue may be the relatively short time frames to complete the acquisition and closing the deal.
Tips on Investing
- Investors contemplating a like-kind exchange should carefully think through the pros and cons. That’s where a financial advisor can be invaluable. Finding a qualified financial advisor doesn’t have to be hard. SmartAsset’s free tool matches you with up to three financial advisors in your area, and you can interview your advisor matches at no cost to decide which one is right for you. If you’re ready to find an advisor who can help you achieve your financial goals, get started now.
- If you’ve decided to craft your investment portfolio alone, you should make sure you’re prepared. SmartAsset has you covered with a number of different online investment resources to help you figure things out. Check out our free asset allocation calculator today.
This article originally appeared on SmartAsset.com and was syndicated by MediaFeed.org.
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6 ways to protect your money from inflation
Inflation has been squeezing — and infuriating — U.S. consumers for a long time now.
What began as an annoyance (an extra pinch at the gas pump and the grocery store) has turned into a painful reminder that budgeting and saving may be even more important than anyone ever thought. And without a plan to deal with inflation’s effects — day to day and over time — your dollars can lose purchasing power.
The good news is that it’s never too late to consider strategies that could protect your money from inflation, while also keeping in mind your personal financial situation, your goals, and your tolerance for risk.
Read on for intel on how to protect your money and yourself from inflation.
Related: What is wealth management?
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Wondering what inflation is exactly? In basic terms, inflation means prices are rising and your purchasing power is declining. You can’t get the goods and services you’re used to buying without paying more for them. And if your income doesn’t increase to match those higher prices — because you can’t get a pay raise that keeps up, or you’re a retiree on a fixed income — it can really impact your lifestyle.
The U.S. has been on a months-long run of record-setting inflation since the start of the coronavirus pandemic. And according to the U.S. Department of Labor Statistics, it’s the costs most people can’t avoid — like food, gas, and rent — that are driving the continued increase in the Consumer Price Index (the most commonly used measure of inflation).
It’s true that there are common causes of inflation and escalating prices aren’t uncommon, but what is happening right now is undoubtedly intense. Rates are hitting the highest numbers the U.S. has seen since the early 1980s, which means it’s the first time many consumers here have experienced inflation at this level.
But even a low inflation rate can erode purchasing power over the long haul. For example, according to the U.S. Inflation Calculator, if you purchased an item for $100 in 2000, that same item would have cost $150.30 in 2020 — before inflation soared. The dollar had an average inflation rate of 2.06% per year in the two decades between 2000 and 2020, producing a cumulative price increase of a whopping 50.30%.
That’s why preparing for inflation can be an important consideration for every consumer, whether you consider yourself a saver, a spender, an investor, or (like most people) you’re a mix of all three.
Recommended: Is Inflation a Good or Bad Thing for Consumers?
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Needless to say, stuffing your money into a mattress or cookie jar probably isn’t the best strategy for protecting your hard-earned dollars.
Not only is an FDIC-insured savings account generally considered a safer place to keep your funds, but you also can earn interest on your money until you need it. Perhaps you’re saving for a down payment on a car or home, a wedding or vacation, or maybe for an unexpected expense.
Although most savings accounts pay minimal interest — usually not enough to counteract even low inflation rates — you’re at least earning something. And if you take time to occasionally review the interest rates various financial institutions are offering, you may be able to improve on what you’re currently getting.
For example, online financial institutions are more likely to offer high-yield savings accounts than traditional brick-and-mortar banks. So, if you’re comfortable with the idea of electronic banking, you may find a significantly higher annual percentage yield (APY). You also might be able to reduce or eliminate some of the fees you’re paying, which can boost your savings as well.
If the Federal Reserve continues to raise its benchmark interest rate in an effort to combat inflation, as it has indicated it will, you may see the rate on your current savings account slowly increase. But if it doesn’t, or if you don’t want to wait around for that to happen, it may make sense to start shopping for a smarter way to save right now.
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Taking the time to reassess the potential earnings from your savings account can be an important step in offsetting inflation’s impact on your bottom line.
But there are other strategies you also may want to consider. Here are steps that can help you protect yourself from inflation.
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It might be hard to believe when the housing market is this hot and prices are this high, but homeownership actually may help protect you from inflation.
If you’re a renter, you’re probably at the mercy of your landlord when it comes to how much your monthly payment could go up when it’s time to renew your lease. And during an inflationary period, your landlord may decide to raise your rent to reflect higher prices. If you decide to move, your new lease also could reflect the high inflation rate. Plus, you’ll have to go through the hassle of finding a new place and moving.
If you buy a house, on the other hand, you’re more likely to have a fixed monthly payment that’s locked in for the life of your mortgage. Another benefit: The value of the home you own may increase along with inflation. And if you hang onto your home until it’s paid off, you won’t have to worry about what housing prices (renting or owning) might look like in the future.
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Especially if you’re a first-time homebuyer, you might feel more than a little overwhelmed thinking about signing off on a 30-year fixed-rate mortgage for, let’s say, $350,000.
It might help to take a deep breath and think about this: According to the U.S. Inflation Calculator, $350,000 in today’s dollars is equal to about $173,000 in 1992 dollars. Thirty years ago, somebody thought $173,000 was a crazy-high amount of money for a house. Now, it sounds like a bargain. It often takes us by surprise how prices (and salaries) do rise over the years.
If you’re borrowing money for 30 years (the most common mortgage term) at a competitive interest rate — and you aren’t paying more than the home’s appraised value — inflation could work for you. That’s because the value of money, including debt, declines as the inflation rate rises. So, the inflation-adjusted value of your mortgage payments goes down as inflation and your property value go up.
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If you have the room and a knack for bargain-hunting, it may make sense to build up a supply of the kinds of goods that could be affected by inflationary prices. This is especially those items that are often linked to shortages.
Unfortunately, it isn’t really feasible for most folks to stockpile gasoline. But your backup supply might include canned goods, baby food, paper towels, toilet paper, and other necessities that you find on sale or can buy for less in bulk.
Keep in mind, though, that if you pay for those goods with a high-interest credit card and you don’t pay off the balance each month, you might not see any savings. (Which is another good reason to keep some money stashed in your checking and savings account to pay for such purchases.)
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The price of durable goods (products that typically last at least three years) also can be affected by shortages and increased consumer demand.
If you need a new car, for example, and prices seem high for the make or model you want, it may be tempting to purchase a lower-quality replacement. Keep in mind, though, that over the long term, you could end up spending more on repairs than you would have if you bought the better brand. Or the less expensive make may not last as long as a better car would have.
You may find it’s a smarter strategy to get an auto loan and invest in the higher-priced car from the start.
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A household budget can be a helpful tool any time, but it could be particularly useful when prices are soaring.
Even if you already have a budget, you may want to reevaluate your spending in categories that are or could be vulnerable to inflation, such as food, transportation, healthcare, and utilities. And you may have to look for categories you can spend less on (at least temporarily), such as entertainment, dining out, clothing, and vacations.
If you’ve put most of your bills on autopay, you also can check for “expense creep” on things like cable and Wi-Fi, subscription services, and utilities.
Sticking to a budget could help you avoid touching your emergency savings when times are tight—or, worse, overusing high-interest credit cards.
Once you’ve established a savings account (hopefully a high-interest one) for your emergency fund and other short-term expenses, you may want to look at investing as another strategy to combat inflation.
Though it carries more risk than keeping your money in a high-yield savings account, investing in stocks, mutual funds, or exchange-traded funds (ETFs) can help you grow your money for the future.
Once again, let’s go back 30 years to get some perspective. According to Officialdata.org’s S&P 500 data calculator, if you had invested $100 in the S&P 500 at the beginning of 1992, you’d come out with about $1,974.20 at the end of 2022 (assuming you reinvested all dividends). That’s a return on investment of 1,874.20%, or 10.42% per year. Even after adjusting for inflation, you’d be looking at a 7.87% return per year — which is better than most alternatives. Which all goes to say that investing may be a very good hedge against inflation.
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What is the best way to protect against inflation?
The best approach may be to prepare for the worst while hoping it doesn’t happen. This means finding ways to get the most for your money as a saver (perhaps with a savings account that pays more in interest), spender (adopting a budget and savvy buying tactics), and investor (with investments that keep growing your money over time).
Where should I put my money to combat inflation?
You may want to start by shopping for a savings account that offers a higher APY and/or lower fees. That way, you won’t be slowly losing money as your cash sits in the bank. Another option is to invest it, which is riskier but may yield you a higher return.
How can I prepare for hyperinflation?
You can use many of the same tactics to protect against runaway or hyperinflation as you would for high inflation. You might decide to stockpile goods now, while your money has value, for example. You may choose to buy a car or make another important purchase sooner rather than later. You also can evaluate what expenditures are “needs” vs. “wants” and budget appropriately. Also try not to panic — which can lead to poor decision-making.
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To younger consumers, today’s high inflation may seem like a new phenomenon. But inflation always has been — and always will be — a challenge.
While you probably can’t avoid inflation completely, with proactive planning, you may be able to blunt its impact on your day-to-day and long-term finances. If you haven’t already, you may want to review your savings, spending, and investing strategies to be sure you’re getting the most you can for your money.
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This article originally appeared on SoFi.com and was syndicated by MediaFeed.org.
Financial Tips & Strategies: The tips provided on this website are of a general nature and do not take into account your specific objectives, financial situation, and needs. You should always consider their appropriateness given your own circumstances.
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