What Is A 1031 Exchange?
What’s a 1031 exchange? Simply put, it is when you sell one property in exchange for another. The big advantage to this exchange, versus the outright sell to buy your next property is, it allows for the deferment of capital gains tax and increases your cash flow, and gives you superior equity build-up compared to stocks and bonds. The IRS does mandate that the properties be exchanged for like-kind properties.
Like-kind properties can be defined as two pieces of real estate that are similar in nature and character. A house for a house, a multi-family unit for another multi-family unit.
This is 1031 exchange is beneficial for people who have to claim over $250,000 per person or $500,000 jointly as a married couple. Say you have a home that you purchased for $100,000 and sold it after 5 years for $300,000, this is not a feature you would benefit from since the IRS already allows each person a $250,000 tax-free exemption.
You would have to get $600,001 from the sale of your home, known as the relinquished property. Then swap it out or re-invest the monies for a like-kind property, known as the replacement property. By doing this you would have created a deferment on your capital gains tax. By repeating this cycle which is only allowed every 2 years, you could potentially defer these taxes indefinitely.
These exchanges are typically for business or investment properties, but it can also apply for former primary residences. If you lived in this former primary residence for less than 24 months in the 5 years that you owned the property, then you are eligible for a 1031 exchange with a partial exclusion of the gain. This will be determined by the amount of time that you were living in it as a primary residence.
With the 1031 exchange and the tax deferment to Uncle Sam, you can also wrap in the closing costs, title fees, broker fees, attorney fees, title insurance, and transfer fees from your sale price, that could save you 30% to 40% in taxes on the sale of your property.
There are other specific requirements to the 1031 exchange that have to be met to avail of this exemption. For instance, a replacement property must be purchased within 180 calendar days; within 45 days of selling the relinquished property, a replacement property has to have been identified; the buyer and purchase must be the same person, and the purchase price and mortgage have to be equal to or greater than the property you just sold.
There are other features and benefits that a 1031 exchange can offer. One, if you choose not to be a landlord, there are options for this. Two, a 1031 can be done with a step-up in basis on inherited property which allows you to pass down the property tax-free to your heirs. Three, if you don’t want to invest all the money from the sale, you can do a partial exchange and just be taxed on the money you chose to not re-invest.
Conclusion
The benefits of a 1031 exchange are numerous. It’s a great way to save cash from the sale of your investment property, increase your cash flow, and build up equity for future generations. It gives you the flexibility of other features to avail of depending on your situation.
Speak to your accountant, business attorney, or qualified 1031 exchange specialist if you think you qualify for a 1031 exchange.
There will be sliding scales of taxation based on your income and specific tax rules for each state, so it is important that you consult a professional to get a clear understanding of your bottom line.
Want to know if you qualify for a 1031 Exchange? Contact us today at (212) 618 1644 or email info@cealegal.com.
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