1031 Exchanges vs. Self-Directed IRAs
Self-directed retirement accounts and 1031 exchanges can both be powerful tax saving tools. Which is right for you?
Savvy investors must prioritize taxes today. The tax you owe or don’t makes all the difference in your total gains, and in the speed with which wealth and passive income can be built. Two of the power-tools for deferring and reducing tax liability for real estate investors are the 1031 exchange and the self-directed IRA (SDIRA). So how do they really compare?
1031 like-kind exchanges enable real estate investors to defer taxes providing they reinvest in another like-kind investment property. In theory taxes on the capital gains from real estate sales can be continuously deferred until the investor can eliminate the liability with other write-offs, or they fall into a much lower tax bracket.
This term can apply to a variety of self-directed retirement accounts including self-directed 401ks, real estate IRAs, and IRA LLCs of checkbook IRAs. These vehicles allow individuals to reduce their taxable annual income based on the deductions they make to a qualifying account. Most of the income and capital gains achieved within the IRA are then tax deferred or tax free.
1031s vs. SDIRAs
While they may appear similar, there are a couple of notable differences between these two tools. 1031s require consistent investment in order to preserve the tax savings. They also allow investors to choose whether to receive some or all cash when sales occur. Proceeds taken as cash may be taxed, but they are not subject to the big penalties which can apply to early withdrawals from a retirement account. SDIRAs appear to have more flexibility in choice of investment. For example; you may sell a multifamily apartment building, and use the proceeds to buy precious metals or stock in a startup venture, without triggering additional taxes. The downside here can be that when financing is used in tandem with an IRA there can be UDFI taxes due. That may be negated with a 1031.
Both have their advantages. And in this case study New Direction IRA actually argues that they could be best used together to save even more.
Which will you use?