Real Estate Q&A: 1031 Tax-Deferred Exchanges and Renters Insurance Coverage
Each month, Zillow Blog contributor Leonard Baron answers two questions from readers regarding buying, selling and investing. Have a question? Send it to Leonard@ProfessorBaron.com
Investment property 1031 tax-deferred exchanges
Hi Leonard — I own a few investment properties, and I want to trade up to bigger properties. I’ve owned them a long time and would like to avoid paying taxes with a 1031 tax-deferred exchange. What are the ins and outs and basics on these? Rob H., Virginia Beach, VA
Hi Rob — OK first, are these investments performing well? If yes, you should really think through whether or not you want to trade up to a bigger property. Trading up to a better property may be a good idea, but not just a bigger one.
When you do an exchange, you might save money on taxes, but you still have the significant transaction fees that all real estate deals incur. So that could easily be 10-15 percent of the sales price — which is a much bigger slice of your equity that is gone, gone, gone due to the transaction.
The basics are simple: Sell one property, sales proceeds are held by a third-party intermediary, buy another property of an equal or higher price. Any taxable gain you would have had to recognize on the sale of the existing property is now deferred until you sell the new property (and it could be deferred indefinitely if you keep doing 1031 exchanges). But don’t forget those transaction fees.
The tough part is that you must identify the property(ies) you plan to purchase within 45 days of selling the first one and close escrow within 180 days. Many people take their own sweet time, and wham: The 45 days go by, the exchange fails, and they pay the taxes!
Make sure to get good quality advice on the rules and regulations way before you start the process to sell the first properties that you plan to exchange.
Hi Professor — I’m considering requiring my existing tenants to carry renters insurance when their lease renews. They’re pressing back a little due to the cost. Any guidance on how to deal with this? Martha M., Cushing, OK
Hi Martha — Renters insurance protects everyone: the tenant, the landlord and people who are guests in the house. It’s pretty inexpensive, generally costing $125-$225 per year for basic coverage.
You can explain to them what it covers and why it is worthwhile for them to carry this insurance. It protects their personal property from damages or theft, covers liability in case someone gets hurt at the property and more (check the policy for specifics).
You could also offer to pay for or chip in for the policy for the first year, or longer. It gives you some protection, too. Insurance covers them for losses so they won’t ask you to cover their losses. Note: Even if you are not legally responsible, that doesn’t mean that you wouldn’t be asked to help by the tenant.
You certainly don’t want a good tenant to leave over a couple of hundred dollars, so think it through and do what you need to so your tenant stays in the property for a long time.
- Rental Homes: Making More Money by Keeping Your Tenants Happy
- Are You Ready to Be a Landlord?
- Rental Property Investing 101
Leonard Baron, MBA, is America’s Real Estate Professor®. His unbiased, neutral and inexpensive “Real Estate Ownership, Investment and Due Diligence 101” textbook teaches real estate owners how to make smart and safe purchase decisions. More at ProfessorBaron.com.
Note: The views and opinions expressed in this article are those of the author and do not necessarily reflect the opinion or position of Zillow.