What is a 1031 exchange? The Internal Revenue Code section 1031 allows you to defer capital gains tax if you reinvest the money made on the sale of your property into a like-kind replacement property of equal or greater value. This can save you a lot of money and can be a great tool to build wealth. You can continue to replace one property with another time and time again. You can even make a 1031 exchange where you buy into multiple properties. Once you sell your property and decide not to reinvest the money into another property however, you will have to pay capital gains taxes on the proceeds of the sale.
Things to Take into Consideration
If you try to exchange very quickly after acquiring a property or go through many properties a year, the government may consider you a dealer and the properties would then be considered stock in-trade, and therefore, would not be eligible for the 1031 exchange rule. Unfortunately, the definition of a dealer is not very clear cut but some experts recommend that you wait at least 365 days between transacting on each given property.
An out-of-state 1031 exchange is perfectly possible. In fact, in most cases you will be able to defer for state and federal taxes if the state has an income tax. The only states, at the time of writing, with different rules are Pennsylvania and Vermont and you should consult with your tax advisors regarding the rules.
Let’s take a different example. If you were to sell your property in Los Angeles and then you bought something in Miami, which does not have state income tax, you would still owe California the state tax once you sold your Miami property, unless you made another 1031 exchange. California, in fact, requires you to file a return, the year you trade out-of-state, as well as every year after so they can keep track of the transaction and ensure the taxes are paid once you sell without doing an exchange.
The Steps to Take
Let’s look at another example to understand the process. You sell your property, let’s say for a million dollars, but you had half a million in mortgage, you would have to buy a property for a million dollars or more with at least half a million in leverage. Then you hand the proceeds to a qualified intermediary, think of it as a special escrow account. You find some like-kind property within 45 days of the sale (this is important; you must designate a property within 45 days of your sale). Then once you agree on a sales price with the seller you have the intermediary wire the proceeds of the sale of the first property to the title holder of the replacement property and you let the IRS know about it. One last item to take into consideration is that the closing of the new property must happen within 180 days of the sale of the original property or you will no longer be able to record the transaction as a 1031 exchange.
The Right Agent by your Side
Sometimes identifying the right property for 1031 exchange real estate can be daunting. You’ll also want to make sure that you’re not rushing to buy a property as it puts you at a large disadvantage and hurts your negotiating position. Keeping all the legalities straight can also be quite trying which is why having the right people by your side will make all the difference in 1031 exchanges. AllView Real Estate Management has an experienced team who can optimize everything about the investment process—from start to finish. At AllView, delivering exceptional real estate management experience is our obsession. AllView Real Estate Management is Orange County’s premier property management and investment firm. We offer not only exceptional property management, but also real estate investment consulting and management. Call us at (949) 400-4275 or send us an email at info@allviewrealestate.com for real estate investment expertise.