1031 exchanges can be an excellent way to safe guard the real estate wealth you’ve built. What is a 1031 exchange? How can you use it to your advantage as a property owner?
A 1031 exchange is a tax-deferred exchange for like-kind property. When it comes to rental property you can use it to sell a property and invest the money in another property without paying capital gain taxes on any profit.
There’re some rules you must follow for restrictions on types of property and the timing of the exchange.
According to the tax code, they include
-property purchased for resale or “flipping” rather than rental
-your primary residence
-personal property not owned by your company
-property outside the U.S
Having a better understanding of the types of properties qualifying for an exchange can open up many possibilities for property owners.
Timing is the second issue in a 1031 exchange. You don’t need to sell and buy a property simultaneously. You do have some time limits you need to consider. These time limits are not flexible. You can’t ask for an extension.
When doing an exchange:
You must identify the new property within 45 days of closing on the sale of the original property. You can identify upon to 3 replacement properties. Identification must be in writing, be specific, and be given to an exchange intermediary or facilitator.
You must close one of the new properties you’ve identified within 180 days of closing on the original property.
You must use an exchange intermediary or facilitator for your transactions. They handle all the documents, the transfer of title on each property and sale and purchase funds. Who you choose is as important and what they do for you. They must be a third party. They must not be family or anyone with whom you’ve had a previous business. This includes your banker, attorney, title company, real estate agent or brokers, you’ve worked with in the past.
The titling and fund reinvesting process for your new property have more regulations to follow.
The title of the new property should be the same as the old property. For example, if the title was in the name of XZY company LLC, the title of the new property should also be in their name. You may run into problems if you are liquidating an old partnership or LLC. Your facilitator can help you through this strategy if you need to liquidate a company.
When it comes to reinvesting the money from the old property into the new property, the new property must be of equal or greater value. To keep 100% of the profit tax deferred, you have to make sure any cash or property purchased follows the equal or greater value rule. The IRS has rules about receiving cash and could result in taxes being paid on a new amount received. Speak to your trusted tax advisor for advice if you plan on taking cash from the purchase.
With all these rules and regulations, why would anyone want to do a 1031 exchange?
There are many advantages to an exchange.
Deferring taxes is the largest advantage to a 1031 exchange. If you are a buy and hold owner, this can be an ideal way to upgrade property over time. This can save you money due to less maintenance and management costs. Other tax benefits include a lower depreciation recapture and possible lower tax rates when you do sell.
There are a few disadvantages.
The disadvantages are the tight rules and regulations in identifying and purchasing a new property through a 1031 exchange. Capital gain tax is only deferred until you sell the new property. It is a possibility tax rates will increase instead of decrease causing you to pay more in taxes upon final sale.
When considering sell and buying rental property through a 1031 exchange, look at all the advantages and disadvantages. Consider how each will affect you and your business. Make the best decision for your goals.
For recommendations of 1031 exchange facilitators contact Day Property Management at 920-968-0626 or fill out our contact form.