At Salt + Stone Property Group, we work extensively with real estate investors. As a matter of fact, real estate investing is one of our favorite topics! One of the many reasons we love it is because we have witnessed time and time again its impact on a person’s financial wellness and freedom. As agents, one of our key responsibilities is to provide our clients with advice and guidance that serves their best interests - and this of course includes their best financial interest. With this in mind, we would argue that utilizing a 1031 Exchange to save money on Capital Gains Tax is almost always in an investor's best interest…But what is a 1031 Exchange?
What is a 1031 Exchange?
This exchange is detailed in the 1031 Section of the Internal Revenue Code that allows an investment property to be exchanged upon sale for a “like-kind” property of equal or greater value - in writing within 45 days, and closed within 180 days. In a typical sale, the proceeds would be subject to a “capital gains” tax. However, because you are exchanging it for another property, this taxation is deferred. Keep in mind that this is only a benefit for investment properties. Primary residences, secondary homes and timeshares are not considered investment properties by the IRS, and do not qualify.
Have a look at this a brief overview of the 1031 Exchange rules:
(Source: Sean Moundry, Licensed Broker)
1. Both Properties Must Be Titled Under the Same Person’s Name - This advantage cannot be utilized by multiple parties.
2. The Second Investment Property Must Replace the Value of the First
The value of the replacement property(s) being purchased must be equal to or exceed the sales price of the investment property being sold.
3. The Purchased Property Must Replace the Debt of the First
Any debt owing on the sold investment property must be replaced by a mortgage of equal value on the replacement property(s).
4. Must Use All the Proceeds/May not access proceeds
To avoid capital gains tax, all proceeds from the sale of the first investment property must be used toward the purchase of the replacement property(s). The proceeds from the sale may not be received by the seller. Instead, the money from the sale of their first investment property must be transferred to a qualified intermediary, who will hold the funds until the replacement property is identified and purchased.
5. Must Exchange for ‘Like-Kind’ Property (or Properties)
The replacement property(s) must be used for the same purpose as the sold property. For example, exchanging an investment property for an investment property is allowed, but exchanging an investment property for a second home is not permitted. “Like-kind” refers to the same usage of the property and not necessarily a house for a house.
6. Must Be Identified in Writing Within 45 Days
The replacement property or properties must be identified in writing within 45 days from the sale date of the investment property that has been sold.
7. Must Close in 180 Days
The purchase of the replacement property or properties must be completed within 180 days from the sale date of the sold investment property. Once the new property is identified, your clients have 180 days from their first closing to close on their replacement property.
As mentioned before, this is a very brief overview of the rules when it comes to 1031 Exchanges. They can be quite complex, but well-worth it! As property values continue to appreciate over time, this tax advantage is expected to be much more prevalent in the coming years. If you are interested in real estate investing, it’s a great idea to familiarize yourself with this process, ask a tax professional, and find a real estate agent that is well-versed in the process.
We can help! Contact us today to get started.
Real Estate Agents are not trained or licensed to provide legal or tax advice. Always be sure to reach out to a lawyer or tax professional for information specific to taxes or legal concerns. Please call us or email us if you need recommendations for a tax professional or lawyer in your area
Author: Haley Elder, Marketing Manager
Salt + Stone Property Group