There are many reasons real estate owners decide to sell and purchase a new property. Reasons include, but are not limited to, tax shelter (e.g., need for a new depreciation schedule); the desire to improve the investor’s holding(s) by selling an inferior property and purchasing a newer, higher-quality asset; and the desire to earn higher returns by deploying equity from a low-yield market to a higher-yield market.
Real estate owners decide to exchange to defer capital gains taxes.
To successfully complete a 1031 exchange, the investor must exchange one property for another property of similar or greater value. In the process you avoid capital gains, at least for a while. An investor will eventually cash out and pay taxes, but in the meantime, an exchanger can trade properties without incurring a sudden tax obligation. The 1031 Exchange Rules require that both the purchase price and the new loan amount be the same or higher on the replacement property.
The term 1031 exchange (aka a “Starker exchange” or a “Like Kind exchange”) is defined under section 1031 of the IRS Code. To put it simply, a 1031 exchange allows an investor to “defer” paying capital gains taxes on an investment property when it is sold, as long as another “like-kind property” is purchased with the profit gained by the sale of the first property. The proceeds from the sale must go through the hands of a “qualified intermediary” (QI) or else all the proceeds will become taxable. The entire cash or monetary proceeds from the original sale have to be reinvested towards acquiring the new real estate property. Any cash proceeds retained from the sale are taxable.
The property owner has 45 calendar days, post-closing of the first property, to identify up to three potential properties. This can be difficult because the deals still need to make sense, and is true especially in today’s highly competitive market. To qualify under a 1031 exchange, you must also purchase all new properties within 180 calendar days (6 months) following the closing of the original property.
As you might realize, there are many rules and qualification requirements that you must comply with in order to perform a successful 1031 exchange. A 1031 tax-deferment is incredibly complicated, even for career investors. A small mistake can jeopardize the deferment of your capital gains taxes, which is why most investors seek professional help.
The multifamily experts at IMG can guide you seamlessly through the process of selling your current property, identifying potential like-kind properties, and representing you in the purchase of your replacement property. As always, consult your tax advisor, CPA and attorney.
Call Karlin Conklin at (971) 888-4010 ext. 104 for more information.
“Making the 1031 Exchange: Is Swap Till You Drop Always the Best Motto?” by: IMG’s Karlin Conklin, Kiplinger Contributor
Video: What is a 1031 Real Estate Exchange? by: David Moore, 1031Exchange.com
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