If you are looking to sell your rental property or Investment property, you may be trying to figure out how you can legally avoid paying taxes on the capital gain. Before 2018, a various different types of assets could be exchanged into different assets but the new law Tax Cuts and Jobs Act of 2017 repealed Section 1031 for all types of property except real property. Lets Learn more about “Avoiding Capital Gains Taxes with 1031 Exchange.”
What is a 1031 Exchange?
1031 exchange is often called Tax Deferred Exchange or Like Kind Exchange. This allows Owners of Real Estate and Real Estate investors to sell one property and roll the gains or profits over to another llike Kind property or multiple properties. On this page, you’ll find a summary of the key points of the 1031 exchange—rules, concepts, and definitions you should know if you’re thinking of getting started with a section 1031 transaction.
What is a Qualified Intermediary 1031?
Qualified Intermediary for 1031 exchange is a independent third party that is responsible for receving money fromthe escrow company, making sure all the timelines are followed and send over the money to escorw for the property that is being purchased.
1031 Exchange TimeLine
Following the 1031 Exchange Time Line is extremely important.
From the date you sell your 1st property, you have 45 days to identify upto 3 properties. Then one or more of these properties needs to be purchased
within 180 days from the sale of 1st property. So the second property(properties) escrows needs to close on or before 180 days.
What is Likekind Property?
A like kind property simply means selling one Real Property and Purchasing another Real Property i.e. Real Estate. This means that there is a broad range of exchangeable real properties. For Example a residential rental can be exchanged for a Vacant Land, for example, or industrial property can be exchanged for Shopping Center.
But you can’t exchange industrial property for stocks or purchasing another business. In order for it to be like kind, it needs to be Real Property and only Real Estate.
The property cannot be a personal residence and held for investment or rental though, not resale or personal use. This usually means the property need to be kept for a minimum of two years or more.
In order for the seller to get maximum benefit of a like kind exchange, property being purchased should be of equal or greater value. See IRS Fact Sheet for More Info
1031 Exchange Rules Exceptions
There are three major exceptions
- You cannot sell Real Estate in another country and do 1031 exhcnage and buy Real Estate in US
- You cannot sell your Primary home and do 1031 exchange and buy a Rental or investment property.
- Cannot do a 1031 exchange within related parties, and either disposes of the property short period or time typically two years.
Benefits of 1031 Exchange
- Instead of filing Schedule D and paying money in taxes, that money can allow you to buy more properties and roll the gain forward.
- You can save Capital gains taxes approx 15 to 20 percent depending upon
- There could be savings at the state level (this varies by state, so your qualified intermediary should be consulted for this information).
- The amount of income taxes paid could be reduced or eliminated eventually through Step up basis
A 1031 exchange is a excellent tool that real estate investors and landlords can use to build wealth overtime. 1031 exchange rules need to be followed very carefully and there are alot of small details. We recomend you seek guidance of you a CPA or EA that can help and guide you though the process. To Learn more about 1031 by visiting IRS website by clicking here
Furthermore, Avoiding Capital Gains Taxes with a 1031 Exchange only works if you have miticulas records and follow all rules related to 1031 exchange.
Otherwise, its common to get audited. In order to avoid IRS Audit, see these tips by clicking here
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10 thoughts on “Avoiding Capital Gains Taxes with a 1031 Exchange”
To simplify 1031 exchange
Sell a townhouse for 450K
Buy a house for 700K
If Borrow a loan for 300K, do I have to income tax gain on the difference of 50K ?
It depends upon if the Townhome was a rental or primary home. 1031 is not for primary home and should be used for Rental or investment properties. It depends upon how much you bought the townhouse for? Also need to consider the cost of fixing up or cost of selling the townhomes. We suggest you talk to a tax advisor who understands 1031 exchanges. If you need specific guidance you should seek a EA or a CPA with at least 10 years of experience to get the best advice.
Navjeet Chahal, EA