If you’re an investor who is looking to upgrade your investment property, but want to avoid the capital gains tax, a 1031 exchange might be the way to go.
The IRS assesses capital gains taxes on the difference between what you pay for an asset and what you sell it for. Capital gains taxes can apply to investments, such as stocks or bonds, and tangible assets like cars, boats, and real estate.
A 1031 exchange is an alternative that could be utilized to help you achieve your financial goals. However, it cannot be used in conjunction with other IRS capital gains exemptions.
How Can It Help?
Thanks to IRC Section 1031, a properly structured exchange allows an investor to sell a property to reinvest the proceeds in a replacement property and defer all capital gain taxes. By utilizing the money otherwise paid to the IRS in taxes, investors can increase their overall buying power to acquire a more expensive and profitable replacement property, which could mean the purchase of a larger, better investment property.
NOTE: Section 1031 is intended for real estate investors. If you are looking for ways to save money while upgrading your primary residence, Julie and her team can connect you with tax professionals who can advise you accordingly.
Are There Requirements?
Although the tax code doesn’t exactly state how long you must hold the investment property for rental purposes to enact a 1031 exchange, most tax professionals agree that one to two years is long enough.
The IRS, though, is clear on two points:
- Merely declaring your house is a rental property isn’t enough. You can’t live in your house at all and you must actually rent it out for some period of time. You can rent out the residence to a relative, provided: 1) the rent you charge represents fair market value for that type of property, and 2) your rental agreement is in writing, and the terms of the agreement are enforced. Most important is the clause dealing with the late payment of rent.
- Once you’ve established that your property is a rental property, you can perform a 1031 exchange and defer the capital gains from the sale. Section 1031 requires the larger, better property acquired be of “like-kind”—meaning it must also be an income-generating residence.
There are several other stipulations that must be followed to validate a 1031 exchange.
- All proceeds from the sale of the original investment property must go towards the replacement investment property, or else they will be taxed.
- The purchase price of the replacement investment property must be the same as or more than the sales price of the original property.
- There are strict deadlines by which you will need to identify and then obtain the title of the replacement property.
Consult A Professional
1031 exchanges are complex transactions. If you plan to eventually upgrade your current investment property by purchasing another investment property through a 1031 exchange, check with a real estate lawyer or tax professional to ensure you’re 100% compliant with IRS rules and regulations at every stage of the process. Julie is familiar with these proceedings, and can refer you to the proper professionals to make your 1031 exchange a success.
Click here for a detailed look at Section 1031 of the United States Internal Revenue Code.
Can We Help?
For more information on how we can help with your upgrade needs, please contact Julie at 650.799.8888 or Julie@JulieTsaiLaw.com to schedule a free consultation.