Tuesday, April 24, 2018 / by Taryn Hale
"No gain or loss shall be recognized on the exchange of real property held for productive use in a trade or business or for investment, if such real property is exchanged solely for real property of like-kind which is to be held either for productive use in a trade or business or for investment." - IRC Section 1031 (a)(1)This little, lovely section of text has saved individual investors thousands of dollars. It enables what we call a 1031 exchange, and in case you didn't quite follow along above, here is what that could mean for you:
If you make money off of an investment property, it is subject to capital gains taxes. Considering the capital gain tax rate is 20 percent, that can be a significant amount of money (although you can reference this blog post to learn more about how you can reduce investment property taxes through depreciation).
However, the 1031 exchange says you can move these funds directly into another investment property and avoid those taxes. This enables you to grow your investment even more, while also deferring taxes.
Here are a few answers to some questions our clients commonly ask.
What does like-kind mean?
Many people assume this means that your investment properties must be really similar. However, the term is actually fairly broad. For example, can even do exchanges with a single-family and a multi-family properties.
How do I find the property I want to exchange at the same exact time?
You actually don't necessarily have to roll your funds straight from one investment property to another. That timing can be tricky to pull off. So you can actually delay the purchase of your next property by using a third party to temporarily hold the funds. However, you still have to close on the next one within six months of closing on the previous property.
Would if I have leftover cash?
Any leftover cash (referred to as "boot") is typically going to be taxed at the capital gains rate. In fact, even having a smaller mortgage would leave the taxpayer with less liability and therefore some extra boot that would need to be taxed. The rule of thumb is to "trade across" or to "trade up."
If you are ready to exchange your investment property, or to purchase your first, then feel free to give us a call so we can help you find the perfect one!