Certainly, most real estate investors are aware that they can sell their properties outright for a profit and then, using that profit, they have the option to reinvest the proceeds into another property if they choose to.
But what some are not aware of is that, provided you follow certain guidelines, there is a way to actually exchange your investment property for profit- and in doing so, you can reap some nice tax benefits in the process.
Exchanging one property for another is referred to as a 1031 exchange. The primary 1031 exchange rules require the following:
- Same Taxpayer – The tax return and name that appears on the tile of the property being purchased must also be the same tax return and titleholder of the property that sells.
- Proper Identification of Property – Prior to closing on the property you are purchasing, you will have 45 days in which to provide the closing entity with the addresses with the properties that you are replacing.
- Replacement – After closing on the first property, you will have 180 calendar days in which to purchase the replacement property.
- Trade Up – It is important that the market value and the equity of the property being sold either be equal to or greater in replacement property value in order for you to deter 100% of the tax. If not, you will be required to pay tax on the amount of the difference.
- Hold Time – Although there is no hold time requirement with a 1031 exchange, the IRS will oftentimes look to see if a property was purchased immediately before an exchange in order to be fixed up and flipped, or rather held for investment.
- Related Party – If the old property is sold to someone who is considered a related party, then that property must be held for at least two years before selling it. Otherwise, the tax that was deferred by the 1031 exchange will be due.
There can be many moving parts to doing a 1031 property exchange. However, it can also be well worth an investor’s time when it is constructed correctly. For more information on how to make the most use of your real estate investments, give me a call. In addition to property management services, I’m also a CPA.