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Section 1031 of the U.S. Internal Revenue Code allows investors to defer capital gains taxes on the exchange of like-kind properties. Defer is the key word here. A 1031 exchange is a method for deferring capital gains tax on a real estate transaction. 1031 exchanges (or tax-deferred exchanges) hold great advantages for all types of real estate investors.
Like-kind exchanges are truly one of the best tax loopholes for the average investor. The catch? You have to keep trading up on property values to avoid taxation. For example, if you bought a property that cost $100,000 and it has increased in value to $250,000, you have a $150,000 gain if you sell it. If you exchange it for another property worth $100,000, the entire $150,000 in gain will be taxable.
So the real tax benefit kicks in when you swap one investment property for another. While there are specific guidelines that cover each type of transaction, there are some general rules that must be followed:
You can eliminate paying any capital gains taxes, and you can eliminate paying the even higher rate taxes on the recapture of depreciation you've taken on your property. By exchanging into a higher priced property you'll also gain additional depreciation deductions which can increase your after tax income.
Yes, you can. By simply following the 1031 exchange rules every time you sell one or more properties and buy replacement properties, when you die your estate escapes all the capital gains taxes forever!
You have 180 days between the closing date on the sold property and the closing date on the purchased property.
Yes, you can buy a new property before selling the old property and still qualify it's called a "reverse" exchange. A qualified intermediary takes title to the new property you buy and holds it for you until you sell your old property.
Yes, one way is to complete the exchange first and then refinance the new property.
Yes, you can acquire any number of replacement properties.
Yes, you can sell any number of smaller properties and trade up to a larger one.
You trade up by getting a bigger loan on the new property, or adding cash, or equities in other properties, or notes carried back from the sale of other properties, etc. Done right, it's all tax free.
Yes, there are many nontax reasons to exchange. For example, if you no longer like managing property, you can exchange your management intensive property for a management free property, or exchange multiple smaller properties for one that can be professionally managed. Or, say your current property cannot be easily refinanced. You could exchange out of that property for a new property which could be refinanced more easily so you can take some cash out. Or, you might exchange to improve cash flow.
Any investor can qualify! Section 1031 of the IRS code lets you sell your property and buy a new property and deferring the payment of taxes owed. You simply follow specific rules. A qualified intermediary can help you qualify and gain the advantages of a 1031 tax free exchange.
Almost every kind of real estate is considered "like kind" and can be exchanged for any other real estate, including vacant land for apartments, a rental house for a shopping center, an office building for a leasehold interest with 30 years or more remaining, as long as you hold them for investment or business use.
Yes, if you do it right. Using an IRA for real estate requires a special Self Directed IRA. Your Self Directed IRA at Charles Schwab or Fidelity does NOT permit you to hold real estate or any asset other than securities. This can be solved by moving your IRA to a custodian that allows for real estate in the plan document. With the right Self Directed IRA (known as Real Estate IRA) and proper structuring, you partner with your IRA to buy leveraged real estate. When it comes time to sell, you can 1031 your portion of the gain while the IRA gets its portion of the gains tax exempt.
The IRS says if you touch the money you pay the tax. However, if you use a qualified intermediary to transfer the money from the sold property into the purchased property, you qualify for a tax free exchange. The IRS does not permit your accountant, attorney, or escrow company to be your intermediary. Qualified intermediaries are members of the Federation of Exchange Accommodators and are bonded.
No, the IRS doesn't allow a person to act as both your qualified intermediary and your attorney or tax advisor. So work with your attorney and CPA to make sure your tax free exchange goes smoothly.
Yes, you can refinance the property you are selling before you exchange, or refinance the property you are buying after you exchange, and the proceeds are taxfree. Check for the details as the timing and contract dates are critical.
Yes, the payments you receive are taxed as you get them, on an installment sale basis. The balance of your equity is exchanged tax free.
Yes, provided your sale has not closed yet, your taxable sale can be turned into a tax free exchange with some simple paperwork.
This article is intended to be helpful and informative. But even common legal matters can become complex and stressful. A qualified 1031 exchange lawyer can address your particular legal needs, explain the law, and represent you in court. Take the first step now and contact a local 1031 exchange attorney to discuss your specific legal situation.