A 1031 Exchange is a great investment opportunity for home buyers. These exchanges need to be understood by buyers, while investment property owners, now or in the future, need to understand the benefits of these 1031 exchanges.
What is a 1031 exchange?
A 1031 exchange is part of the Internal Revenue Service’s tax code which allows for an exchange of ‘like properties’. This exchange can be a very beneficial way to postpone capital gains taxes on your investments sales.
In real estate, a 1031 exchange on property is for ‘like kind’ properties that are in the United States. It is a sale of one property and the purchase of 1-3 (or more) properties of the same market value (in total or more), or not more than 200% of sold property, or as many properties as desired but at least 95% of the initial first property sale amount. See why you need a good certified public accountant!
Why does one do these 1031 exchanges?
First, it can not be done on your primary residence and secondly, you do it because there are tax advantages that will SAVE YOU MONEY. I am not an accountant, so make sure to talk to someone in the field to explain how it will benefit you specifically.
The Tax Advantages of a 1301 Exchange
Let us look at what advantages you can gain by doing this with an investment property. Well you want to be in a lower capital gains bracket when you finally sell investment real estate and you want to take a property gain when your capital gains is the least monetary taxable amount.
Why pay the government tax now when you can pay later at a lower capital gains rate? 1031 exchanges have a very finite time limit point to be aware of when you start on this road and an ‘qualified intermediary’ (third party) usually must be part of any 1031 transaction you do.
What kind of time limits are you talking about? Once you sell your investment property, when doing a 1031 exchange, you have 45 days from closing to identify the ‘like kind’ properties. Remember ‘like kind’ property must be exchanged for equal or greater value than the property you are selling. If it is not, you will be responsible for a capital gain tax. In addition, the investment property you are buying must take place within 180 days of the closing of the first property or within the tax year of the 1031 exchanger (whichever is less).
Since we are talking about ‘investment’ property as such in real estate, the capital gains exclusion of $250,000 if single or $500,000 if married does not come into play here (since this capital gain exclusion is only for principal residences). If at some point you want to make the investment property your primary home, then sell and use the capital gains exclusion, you must, as the owner, hold the home as principal residence for a period of years first (at least five years) prior to selling it.
What does this all mean to you as a potential real estate investor?
Talk to your accountant and CPA to ensure you will have a qualified property to do a 1031 exchange and do it without triggering a capital gains tax now. This is an untapped business product that can allow your real estate investment to grow untouched by Uncle Sam for a number of years. If you have any questions for me, please feel free to contact me directly.