If you are looking to sell your house in the future, you should know about a 1031 exchange. This tax benefit is a great tool which allows real estate investors to defer capital gains taxes on the sale of real estate. If you are in the process of selling your house, or looking to sell in the future, definitely keep reading. If you plan on making a sale in the future, a 1031 exchange can save you when it comes time pay taxes from selling your home.
What is a 1031 exchange?
A 1031 exchange enables investors in real estate to defer the tax on any gain on the sale of an asset. In order to take advantage of this, the proceeds of the sale must be reinvested into a new property. This new property must be of equal or greater value than the original one.
There are many factors that go into determining if you qualify for a 1031 exchange. If you sell a property and want to take advantage of a 1031 exchange, you must identify a new one within 45 days. You must also purchase this new property within 180 days of the original sale.
In addition to this, not cash or debt can be assumed on the sale of the property. Plus, the seller of the original property and the buyer of the second must be the same person. In this case, the seller or buyer can also be the same entity (if you are a business).
This entire process can be confusing. You must follow all of these rules if you want to be able to use the 1031 exchange. Because of this, you may want to use a 1031 intermediary. A 1031 intermediary is usually an accountant or attorney, and they can help facilitate the transactions.
Capital Gain Recognition
A 1031 exchange is definitely a useful tool, however it may not be for everyone. First, in order to qualify, you have to have a gain in the sale of your house. This is a simple calculation. All you have to do is find the original purchase price then add the cost of any major renovations. Next, add in the cost of any selling expenses and fees. Lastly, you subtract the selling price from this total. If the number you arrive at is positive, then you have a gain. If it is negative, you have a loss. Individuals do have some opportunities to get around paying capital gains taxes on the sale of real estate. For instance, if the gain is under $250,000 for a single filer, or $500,000 for join filters, you usually will not have to pay capital gains taxes.
Depending on your financial situation, a 1031 exchange can save you big time on your taxes. Note that these really are geared to those investing in real estate and not so much individuals just selling and buying a new home.
To make sure you can avoid the gain, you may want to use an intermediary to hold the funds from the sale. The intermediary will also be able to help you purchase the new property.
Time is a Key Factor
When looking into a 1031 exchange, you have to meet strict deadlines to qualify. Remember, a new property must be identified within 45 days of the sale of the original property. You must then purchase this property within 180 days of the original sale.
If you do not follow this timeframe, you will have to recognize a gain which is a taxable event. Using an accountant or attorney, or other professional as a 1031 intermediary, can help in making sure you meet these deadlines.
Reasons to Avoid a Gain
If you want to avoid paying capital gains taxes on a real estate transaction, then you should know about a 1031 exchange. There are several reasons why someone would want to avoid a gain, especially if you are investing in real estate.
If you recognize a short term capital gain on the sale of real estate, and don’t use a 1031 exchange, you will have to pay taxes. Instead of being able to reinvest these funds into a new property, you will be sending it to the government in the form of taxes. As an investor, you want to make sure you get the most bang for your buck. This will translate into a higher return on investment for the property. If you have to pay capital gains taxes, you will be leaving money on the table that you can’t utilize.
Things to Know About a 1031 Exchange – Summary
As a real estate investor, you need to know about a 1031 exchange. As an individual home owner, understanding the details and complexities of a 1031 exchange can also be beneficial. This type of tool allows real estate investors to defer capital gains taxes on real estate transactions. Remember, you are just deferring the tax. You will eventually need to pay them if you cash out and sell your properties.
While there are many 1031 exchange requirements that need to be met to to successfully complete an exchange. Although there may be some headaches along the way, it can definitely be a rewarding process and be worth it in the end. Instead of having to pay taxes on a sale, you will be able to reinvest these funds in a new property. If you are thinking about a 1031 exchange, be sure to remember the stringent time frame for identifying a new property and ultimately buying it. An accountant or attorney can help you throughout this process if they are acting in the capacity of a 1031 exchange intermediary.
At the end of the day, a 1031 is a complicated process. However, it can increase your rate of return and this is something all real estate investors should be striving for.