February 20, 2016 - 12:00
I am sure you would like to sell your rental property at some point but have thought about the amount of taxes you will pay on that gain. But don’t worry, there is a method that allows any investors to defer paying any property taxes on the property when it is sold and allowing those gains to be used on the next property purchase. It is called the 1031 exchange and it can completely change the way you do business, help you save on taxes and build more wealth for you.
Understand that the US government encourages real estate investors because we help provide housing for the masses. In return the government “partners” with the investor by letting him or her use the total gains of the property sold and buy a ‘like-kind’ property without owing any taxes. Although the taxes will be due some day, it can be very rewarding to keep using the government’s money to invest in properties.
Johnny bought a home located in Houston, TX in 2010 for $70,000. It appreciated very quickly and in 2013 he sold the property for $135,000 using the 1031 exchange and gaining $65,000 in profit. Because he used this method he saved around $15,000 in capital gains tax and was able to use the full $135,000 to purchase two single family homes which resulted in two rental incomes.
To fully benefit from the 1031 exchange you need to follow the few simple rules that are set up:
1) 45 day identification window
This means that when you sell your property, a 45-day timer starts ticking. What you need to have in those 45 days is three potential deals listed, in case the first does not go through. Once identified it is time to move forward because another timer has been ticking.
2) 180 day closing window
At the same time the 45-day timer starts counting down, so does the 180-day closing timer. The IRS requires that the new replacement property be fully purchased, title fully transferred, within 180 days. The entire exchange will fail if you do not meet both deadlines.
3) Like kind
This requires that the property being sold and the property being acquired be ‘like-kind assets’. Which means that both exchanges have to be a type of real estate investment, in other words you cannot trade a merchandise store with an apartment complex.
4) Equal or Greater value
The IRS requires that the replacement property be of equal or greater value than the property being sold.
Finally, if you hope to avoid taxes with the 1031 exchange, remember that you cannot touch the money of the sold property. The gains from the sold property will never enter your bank account; instead you will use a qualified intermediary to hold your money until you purchase the new property.
Once the exchange is done correctly, you will truly benefit from learning a new strategy and gaining more wealth.