If you invest yourself Property – such as a house, condo, apartment building or commercial property that you rent – you usually have to pay Capital gains tax On the profits when you sell the property. But you may be able to eliminate the capital gains tax liability by exchanging 1031, which is a kind of exchange for other assets of equal or greater value. The rules are complicated and the time frame is tight, and it is easy to make mistakes that can buy into a large tax bill or haste which may not be a good investment. Here you need to find a 1031 exchange to work and an expert who can help with the transaction.
What is a 1031 Exchange?
If you own a business or investment property, you can benefit from the 1031 Exchange. By purchasing another type of property of equal or greater value, you may be able to defer the capital gains tax bill in the future – or avoid capital gains taxes if you die before selling the final property.
You can use the 1031 exchange if you file your tax as an individual, limited liability company, C corporation, S corporation or other types of entities. “Any taxpayer who owns real property interests and can meet the requirements of section 1031 or avoids profit or loss,” says Holly Belanger, partner at KPMG’s Washington National Tax Practice. “This provision is not limited to particular types of taxpayers.”
A 1031 exchange can be particularly useful if you want to sell your property now, but you expect your capital gains tax rate to be lower in the future. For example, this can be beneficial when you are currently in your peak income years but your tax rate is expected to fall after you retire. And if you die before you sell the last property, your heirs may receive a step-up in the basis and you will not have to pay federal capital gains taxes on the increase in value during your lifetime. The rules may vary by state.
It does not apply:
The 1031 exchange is not for your primary residence but for investment and business property. Your own house is under one Individual tax breaks It can be overpriced: If you have lived in a home as your primary residence for two of the last five years before the sale, you can exclude up to $ 250,000 in home sales gains from taxes when you are single. Up to $ 500,000 if you are Jointly married. You do not need to buy a new house or roll it to get tax exclusion for your primary residence. $ 250,000 or $ 500,000 in profits from selling his primary residence are excluded from taxes – not just deferred. Some people who own a rental home move it as their primary residence for at least two years before selling so that they can benefit from this exclusion rather than doing a 1031 exchange.
1031 What type of assets are eligible for exchange?
To be able to defer all capital gains taxes, the value of the new asset must be at least as much as you are selling. “The taxpayer must reinvest all of the net sales proceeds in the purchase of one or more in-kind replacement real properties of equal or greater value than the value of the property sold,” Bellager says.
The definition of “like-kind” is broad – new property must also be immovable property used for investment or commercial purposes, but does not need to be the same type of building or land. “The assets should be specifically intended for investment or commercial use,” says Rob Johnson, wealth management and chief revenue officer at Real Estate Holdings, a technology-enabled platform that provides investment property wealth management for real estate investors is. “There is a great deal of flexibility within this definition. Properties do not need to be the same type, nor are they located in the same state. For example, building a rental house in California, an industrial building in Virginia. Can be done for; raw; can be exchanged for a retail building in Texas in Michigan. ”
Your The mortgage The balance should be at least of the same level, too. “If you had a mortgage on an old property, you should have a mortgage on the new property for the same amount or more,” says Michael Eisenberg, a CPA and financial planner in Encano, California.
Philip, president of CPA, Kroon & Mitchell, president of Philip & Mitchell, and member of AICPA’s Personal Financial Plan, says that you should roll on the market value of the property as well as the debt level. executive Committee. “If those two components are not met, there will be a capital gain.” If you buy a new property of lesser value, you can still reduce the capital gains.
What is the time limit to find a new property?
You have limited time to identify new property and close the sale. You have up to 45 days after selling the first property to identify some properties you are considering purchasing for the exchange. You can usually identify three possibilities. You must close on the sale of one of those properties within 180 days of the first sale. Mitchell says, “If you don’t fit within that window, you are not eligible.”
If you sell the first property quickly and have not yet identified a replacement, start searching for one immediately. “When the inventory is tight, you need to look immediately,” he says.
Another important rule: You cannot touch the money from the sale of the first property and still qualify for the exchange; You need to work with a qualified intermediary who ensures that the transaction is in compliance with the requirements of the IRS. It is necessary to find a qualified intermediary before selling the property first.
Johnson says, “If an investor controls sales proceeds, the 1031 exchange is void and they have to pay taxes.” The qualified intermediary has three main responsibilities that ensure that the 1031 is in compliance with IRS regulations: withholding the investor’s cash income from the sale of assets Escrow As required by the IRS, documenting the identity of the investor of the replacement property within a 45-day period and facilitating and documenting the investor’s purchase of the replacement property by transferring the investor’s funds to the title company / seller, Johnson says Huh.
Belanger states that the taxpayer’s family, employees, accountants, lawyers, real estate and investment brokers may not work as facilitators, but CPAs or real estate agents can usually recommend a facility. There are many narrators Federation of Exchanges, She says.
Is 1031 Exchange Right for You?
If you are in a high, 1031 exchange may be particularly helpful. tax bracket Now and later you will want to avoid taxing the property sales till you are expected to be in a lower tax bracket. For example, if you are in your peak earning years right now, but you expect that when you retire in a few years, it will be lower. This may be the right step for you.
The 1031 works best if you die before selling the last property. In that case, you can avoid the capital gains tax bill and the tax base will be “phased out” at the time of your death. For his heirs, Eliminating capital gains taxes on the increase in value during his lifetime. Mitchell said, “This is the holy grave.” “For people with substantial savings who will never need money, this is a great inter-planning tool.”
Additionally, hastening to buy a new property to defer taxes can be a mistake but possibly a bad investment. “Just because you can defer taxes doesn’t mean it makes the most sense,” Mitchell said. “Make sure you don’t just buy a property to gain profits, but buy a property that you need.”
In their area, the real estate market is so tight that people who are selling for a large profit may have trouble finding an inexpensive new property to buy within a tight timeframe. “What kind of risk are you taking because of a tight timeline?” Says Michelle. “Have you just found something so that you can exchange? Are you not getting the right thing and the right price and buying something that doesn’t make the most sense?”
Consider also what the future capital gains tax rates may be. “There are times where 1031 can be very beneficial, but you have to weigh the situation you’re in.” “We don’t know what the tax law will be down the road.”
For assets held for more than a year, depending on your income, now the capital gains rates are very low – 0%, 15% or 20%. If you know that you will soon need money from property sales and are now in a lower capital gains bracket, you may want to think carefully before paying tax. “If you are in a lower capital gains rate, then it makes sense to take advantage of those lower rates. What would happen if the future capital gains rate changes?” Says Michelle.
1031 What to do before creating an exchange
With such a tight timeline for exchange, try to do as much in advance as possible. If you yourself Investment property, It is a good idea to meet with a CPA or financial advisor before you plan to sell your property to find out how the 1031 exchange can work for you and what type of property will qualify. Think about the time that might be best tax-wise if you eventually need to sell the property for cash and pay capital gains tax, such as in a year when your income is low.
Think about what your taxable income is this year and what you think it will be down the road. It’s like a game of chess – you’re trying to think a few steps in advance, “Mitchell says.” For those who plan to sell the property, we should plot it. I tell our clients that we need to forecast an income for the next five years and have a good year. “