What is a 1031 Exchange?
Real Estate Investment Strategy
A 1031 exchange is a real estate investment strategy. While there are many ways one can invest their money, not all investment strategies work the same. That said, if you enjoy both high-risk and high-reward, investing in the stock market will benefit you. On the other hand, some people like investing in stability. The truth is, investing is different for each of us. And, the more you know about who you are and what you want. You can determine your level of risk. No matter what type of investor you are and what type of investor you are not, knowledge is key.
There is nothing more exciting than turning on your mobile device in the morning to get the latest stock quotes. And, while there are advantages like high-returns and disadvantages like high-risk, before diving into the stock market make you understand each. With that said, stocks are volatile and fluctuate in value on a daily basis. In fact, it is important to have patience when investing in the stock market.
For some investing in the stock market makes sense. And, for others acquiring real assets like rental properties means securing their future. A future built with residual income. In fact, that is just the type of income for those looking to retire. Investing in rental property has many favorable tax benefits. Such as, depreciation to save on taxes. Additionally, a 1031 exchange, will allow you to sell a rental property and defer the taxes on any profits you make.
Please note: Town Real Estate is a real estate broker. We are not accountants or tax attorneys. This article should not be used as tax or legal advice…
What is a 1031 Exchange?
1031 Exchange 101
A 1031 exchange is a real estate transaction involving two like properties, one is sold and one is purchased within a certain timeframe. A rental property will qualify under a 1031 exchange because the IRS considers a rental property as one that is held for productive use in trade or business. One might consider a 1031 exchange when selling a rental property for the purpose of moving the profit and recaptured depreciation to another similar property without paying taxes.
Under IRC Code Section 1031 the IRS explains,
Whenever you sell business or investment property and you have a gain, you generally have to pay tax on the gain at the time of sale. IRC Section 1031 provides an exception and allows you to postpone paying tax on the gain if you reinvest the proceeds in similar property as part of a qualifying like-kind exchange. Gain deferred in a like-kind exchange under IRC Section 1031 is tax-deferred, but it is not tax-free. (IRS, 2008, Para. 1).
Selling an Investment Property and Reinvesting in a New One
Capital gain taxes become due when you sell an asset for more then you invested. As a result, when selling an investment property you have to consider your gains. The reason is simple, selling could result in a significant tax liability. Resulting in an unplanned tax payment. If you are not planning on taking money out of your rental property you might want to consider a 1031 exchange.
1031 exchanges also known as a like-kind transaction doesn’t mean you have to exchange your four-bedroom rental property for another four-bedroom rental property. You can sell your four-bedroom rental property and purchase undeveloped land as long as the asset on both ends of the exchange is real property, located in the U.S. and not for personal use.
According to Realtor.org there are specific factors that you should know about 1031 exchanges,
- Section 1031, which allows for “like-kind exchanges,” has been in the tax code since 1921, with the most recent significant modification in 1991. It is a very well established provision.
- A 1031 like-kind exchange is not a tax “loophole,” but rather a deferral – the owner pays tax on the property when it is ultimately sold for cash, as opposed to when it is exchanged for another property.
- Any cash you receive as part of the deal – for example, if the property you receive is valued lower than the one you exchange it for and you receive cash for the difference – is taxed as partial sales proceeds (usually at the capital gains rate).
- 1031 exchanges are only allowed for investment or business property, but in some cases can be used for properties such as vacation rental homes, and for tenants in common real estate.
- Timing is important. A “replacement property” must be designated within 45 days of the sale of your property, and you must close the deal on the new property within six months (180 days) of designating it. (Realtor.org, 2015, Para. 1-5)
Whether you are looking to buy a new home, second home, investment property or need help finding the perfect property for a 1031 exchange. We have Palm Springs Real Estate listings to fit your unique lifestyle…
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Commercial Connections, Summer 2015: Advocacy: 5 Things to Know About 1031 Like-Kind Exchanges | realtor.org. (2015, June 19). Retrieved October 19, 2015, from http://www.realtor.org/articles/advocacy-5-things-to-know-about-1031-like-kind-exchanges.
IRS. (2008, February). Like-Kind Exchanges Under IRC Code Section 1031. Retrieved October 19, 2015, from https://www.irs.gov/uac/Like-Kind-Exchanges-Under-IRC-Code-Section-1031.