As the cost of living increases and inflation skyrockets, more individuals want to move to more affordable housing. Mobile home parks are low-maintenance living options that offer a sense of established community via close-knit environments. They require little to no property upkeep and also provide flexibility to those who are unsure of where they want to live permanently.
With more interest in housing environments such as mobile parks, it’s an excellent time for investors to get in on this type of transaction. Due to the sheer number of units per lot, mobile parks can create a higher cash flow than single-family homes or apartment complexes. The IRS also offers tax benefits for investors, including the 1031 exchange.
Simply put, a 1031 exchange is a tax-deferred real estate transaction that allows an investor to trade one property for another without significant tax implications. When done correctly, a 1031 exchange can offer significant tax advantages for those interested in investing in mobile homes. Here are some 1031 exchange strategies mobile home park investors should keep on their radar.
Defer Depreciation Recapture Taxes
The good wears out over time when you buy a physical object — such as a building, car, or machinery. For accounting and tax purposes, this is commonly referred to as “depreciation.” Instead of dedicating this depreciation cost during the year of a sale, it is spread out over several years. The cost of annual depreciation deductions must follow specific rules laid out by the IRS, including how much an owner can write off every year.
Depreciation is also taken into consideration when an owner sells a property. This makes sense because you are no longer selling a good that isn’t in its prime condition. As a result, you must decrease the amount of your investment in property tax purposes (or basis) by the amount of depreciation you’ve made over the years.
If you are currently invested in a mobile home or similar asset-class property, you can take advantage of a depreciation recapture via a 1031 exchange. When selling a property, owners must pay a tax on the gain realized. This can be a significant amount, depending on the new property. But thanks to the 1031 exchange, this depreciation recapture can be deferred when buying a “like-kind” replacement property. This postpones the capital gains tax payment from the sale while you search for a suitable replacement property to purchase.
When it comes to deferring and 1031 exchanges as they relate to mobile home parks, Lifestyle Investing expert Justin Donal addresses some key information, saying, “If you hold for the long-term or if you do a 1031 exchange or a like-kind exchange, so you basically sell an asset, and you buy another asset inside of that a similar vertical, then you’re able to defer that tax again and kind of kick the can down the road. So, you don’t always have to worry about a recapture if you have a good plan or time on your side to make those adjustments.”
Preserve Equity
Another advantage to investors with the 1031 exchange is the ability to preserve equity. Equity is the value of an asset minus the cost of any debts, such as mortgages. For mobile home park investors, equity can be a powerful tool to pay off debt, invest in additional parks, or make improvements to current ones.
You’ll want to preserve your equity because it ensures your investment remains stable and secure. This will help as you invest in similar or new types of properties. It’s related to your credit score, which can impact deciding what kind of investment you want to pursue next. From a tax efficiency standpoint, preserving equity can also decrease your overall tax impact during the 1031 exchange transaction.
Reset Depreciation on New Acquisitions
Finally, a 1031 exchange does not reset depreciation on your newly acquired property; instead, the depreciation schedule from the “like-similar” property transfers to the new property. This means that how much your older mobile home park depreciated is kept in mind during the sale of the new home park. You won’t be starting fresh just because you decided to buy another property in a similar condition to your older property.
This also means that you will continue to depreciate by the same amount over the tenure of your current mobile home park investment. You will not need to start or “reset” your depreciation schedule for the replacement purchase. This also means your taxes won’t significantly change based on deductions across properties.
It’s important to mention that if you upgrade your investment, the depreciation value may be impacted. Let’s say the mobile home park you’re buying is deemed of higher value than your older property. In this case, you will likely need to calculate depreciation via the exchange basis from the older property and the excess basis from the value of the new property. This new depreciation will account for the trading up in value due to the sale.
Final Considerations: Speak with a Tax Professional
1031 exchanges can provide significant benefits to investors of mobile home parks. However, real estate investing can be a tricky business, so it’s important to consult with a tax professional before engaging in any transaction. A professional will know the IRS regulations and any state or local rules concerning investing in properties such as mobile home parks.
When speaking with a tax professional, talk about your investment goals. They can suggest ways to fine-tune your investment strategy while offering advice on avoiding tax complications. They can also handle any necessary forms and paperwork to ensure you abide by the tax laws and that the transaction is as smooth and seamless as possible. Just because you’re the investor doesn’t mean you must go down this path alone. Working with a tax professional can put your mind at ease while also assisting you in reaping the rewards and tax benefits of the 1031 exchange.
