Did you know there actually is a way to sell real estate and pay no tax on it? A 1031 Exchange can allow a business owner to sell their property and reinvest the proceeds into a replacement property with no immediate tax consequence to that transaction. They can defer any capital gains taxes associated with that sale.
The first step to using a 1031 Exchange is getting a qualified intermediary. This can be a company, lawyer or individual who is accredited for this purpose. The qualified intermediary will hold money (like an escrow account) when you sell the current property. Typically, law firms will help with 1031 Exchanges and if you are working with a real estate company, they may have a recommendation. This is usually very affordable compared to the money that can be saved.
The second thing you need to know is that you can’t pull or touch any of the cash involved in the transaction. It is possible to do a partial 1031 Exchange, where you can take a certain amount out, but you will pay tax on the money you take out.
A third thing to understand is that you need to buy a property that is more expensive than the property you are selling. The mortgage must be the same or more than the old property. If you don’t buy something more expensive, you can’t necessarily avoid taxes.
What kind of property qualifies? As long as the new property is an income producing property that is replacing another income producing property, it should qualify. It doesn’t have to be the same type of property. It is possible to sell a commercial property and buy an industrial or rental property and doesn’t have to be 1 for 1. You could sell one property and buy 3 or vice versa, for example.
The trickiest part of using the 1031 exchange is that the process must be completed in 180 days. The timeline of the 1031 exchange can be confusing. As soon as you sell your first property, the clock begins ticking. Then, you have 180 days to identify, get funding for, close on and settle on the replacement property. This can go very smoothly if you have another property already picked out, however, if a deal falls through at any point in the timeline (which can happen in real estate), it can complicate things very quickly.
One of the best ways to deal with this timeline, is to line up the sale of your existing property within a week of closing on your replacement property. This way, by the time you get to close on your sale property, your new property is vetted and ready to close on as well.
While you can’t necessarily get rid of it completely, a 1031 Exchange allows you to defer your capital gains tax, which can help with things like estate planning. If you want to pass down your property to your kids after you die, your kids won’t necessarily have to pay the capital gains tax. It can also help with things like vacation properties as long as you find a way to make money on the property. If, for example, you sell your automotive shop and want to buy a vacation house, you can use it as a rental property as well and still qualify for a 1031 Exchange.
The best thing to do is to talk to a qualified professional and do your research to make sure that any property or investment goes through the right channels to avoid complications with the IRS.
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