When using 1031
Exchange to avoid taxes, remember there are only two certainties: Death
and Taxes. I suspect you never avoid taxes. The only way I see to avoid taxes
is not to invest.
What is a 1031 Exchange? A 1031 exchange is mostly
relevant for people with rental property. The 1031 exchange is for real estate investors who want to use the
proceeds from the sale of one rental property to purchase another rental
property and defer capital gains taxes. Defer not avoid.
Why Would I Use a 1031 Exchange?
The purpose of a 1031 exchange is to defer paying 15 percent taxes
on capital gains. If you sell a property and you’ve made some money on it, you
pay 15 percent on your gains. If you defer your taxes by using a 1031 exchange,
you don’t have to pay the IRS as long as you roll that money into another
investment (rental) property
Keep in mind, the taxes you defer paying could be as high as 30
percent when you consider depreciation costs, etc. On the surface, it’s the 15
percent capital gains tax you are avoiding or defering here.
The rule works for like-kind
properties in question must be used for business or as an investment. This means
the rule excludes primary residences, which are for personal use the majority
of the time. Like-kind property also
must be within the United States to qualify. For example, a seller cannot
use the proceeds from selling a hotel in the U.S. to buy a hotel in London and
expect to defer capital gains on the sale. Securities, stocks, partnership
interests, and other financial assets are
excluded from the definition of like-kind property.
From the day you sell
your initial rental property, you have 45 days to find a property you wish to
From the day you sell your initial rental property, you have 180 days to
close on a new property.
You must purchase property of equal or greater value than the
adjusted value (not the price value — but the adjusted cost basis when
taking into account depreciation less
commissions and closing costs) of the property you sold, or you will be
taxed on the difference.
Warning: If you do not close on a
property within 180 days of selling your initial property, you pay
the capital gains tax on your initial property.
During the interim of selling your first place and closing on
your second, you cannot touch/look at/get close to the profits from the
first place you sold. That money stays with a 1031 exchange facilitator
(qualified intermediary) and not, not, not with you.
The old property and the new property must be sold and bought
by the same entity. Meaning, if you sell a property as John Smith, you
have to buy the new one as John Smith — and not as Smith, LLC.
Experts can debate this point, but a good rule of thumb for
the majority of you is this: You must own your property for one year and
one day to make this 1031 exchange. Otherwise, The IRS will penalize you.
There is no limit how many times you can roll a transaction
forward, avoiding paying capital gains. Eventually, the end will come, and
you will pay your taxes.
These are the basics of a 1031 exchange. If you have more
questions, reach out to a 1031 facilitator, a trusted tax professional, or
someone you know and respect in real estate.
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