For those investing in real estate properties, IRS regulations become a primary consideration, especially those that mean to benefit the investor when it comes to decreasing their responsibilities after earnings.
One option that works toward that end is a 1031 Exchange option. It boasts a valuable tool when facing capital gains or potential other taxes—these result when you sell a real estate property for a high price point that you originally paid. The capital gains on that difference would be considerable.
Fortunately, this tax payment can be deferred if the proceeds you earned with the transaction are reapplied to another investment in a sort of exchange instead of considering the transaction of an all-out sale.
The exchange removes the liability from what might have been deemed a sales profit but is instead seen as trading for something of greater value.
The 1031 exchange comes with stringent guidelines dictating what warrants a legitimate trade with rules that must be adhered to. Let’s look at the regulations closely to ensure you comply when applying this option to your investment. Find out what you should know about the 1031 exchange at https://www.investopedia.com/financial-edge/0110/10-things-to-know-about-1031-exchanges.aspx.
Section 1031 Exchange | 1031 Exchange Rules
The 1031 Exchange is an option for investors that helps reduce the capital gains and other taxes associated when real estate investments are sold for higher price points than initially purchased, creating a profit.
Instead of keeping the cash, the investor does an exchange with the funds, trading up for another investment. When deciding to do a 1031 exchange, there are stringent guidelines that need to be adhered to.
You will need to understand that the funds will be held in escrow, which a third party will monitor until the close of the new real estate. The money proposed for a 1031 exchange can only be used for trade. Check these rules and regulations.
- “Like-kind investment property”
A 1031 exchange mandates that the funds be used for a “like-kind property.”
The property in an exchange must fall under the definition of “like-kind,” meaning you couldn’t sell an international option and reinvest in a domestic property. However, you could choose to take the proceeds from an apartment building and reinvest these in an industrial venture.
If you can’t find the right real estate to make a new investment, you should avoid the exchange option.
- A deadline is imposed
At one point, investors need to do a relatively immediate exchange upon selling the property. That has been updated to provide a 45-day turnaround to allow time to handle the varied processes involved with selling and reinvesting real estate properties.
When attempting to navigate paperwork, transitioning titles, and transferring money, it can take more time than what was allotted previously. The 45-day timeframe is still tight but is firm.
The indication is an investor has to either close the property or report with the replacement identifying documentation within 45 days of the original real estate being sold.
That is a straight 45 days, not business days; it includes holidays and weekends. If you’re unable to accommodate this timeframe, there is a disqualification of the exchange.
That doesn’t mean the IRS will negate your chances of buying the new property but will enforce the taxes for the real estate you sold.
Final Thoughts
There is a range of rules with some pertinent to specific states. It’s wise to research when you’re in a position to take advantage of the 1031 exchange, how to do so, and the regulations for your local area. Go here for details on 1031 exchange rules.
The option allows an investor the opportunity to delay capital gains taxes from selling real estate investment property. Capital gains can range as high as 30%. You avoid taxes and keep the funds working for you by reinvesting the proceeds.
Leveraging the money you would otherwise use for capital gains to swap for a “like-kind” property allows a more shrewd investment strategy. It helps you to grow your wealth, taking your real estate ventures in a direction you might not have anticipated.
It won’t always work seamlessly or be as straightforward as it sounds, so you must be prepared for the potential downsides. That could mean having capital gains ready in case you get stuck needing to make the payments.
