Knowing what real estate investment options are available to you is not only intelligent but also essential. And now is a better time than ever to make some smart investments. One of the ways you can be a smart investor is to look into 1031 exchanges. This method allows you to avoid capital gains taxes on selling an investment property.
The 1031 exchange gets its name from section 1031 of the IRS code. It allows you to exchange one property for another, and it’s tax deferred! But to properly qualify for this tax deferment, you need to buy the new property with the profit you acquired from your recent sale. Moreover, the new property’s purchase price and loan amount must be the same or higher than the previous home’s.
Not only do you save from the tax deferment. You can also save in the kind of exchanges you make. For instance, exchanging a high-maintenance property for a low-maintenance one can result in great gains. If your property has acquired more value over your period of ownership, a 1031 exchange can be very profitable.
Types of Exchanges
Simultaneous exchange: when you swap the houses and close on the same day.
Delayed exchange: the most commonly used type of exchange, when you relinquish your property before purchasing the new one.
Reverse exchange: when you buy your replacement first and then exchange. This is difficult because it requires cash payment, and banks rarely offer loans for this type of exchange.
Construction Exchange: allows you to fix up the replacement property with your profits from the sale.
How to Qualify for an Exchange:
Like-Kind: In order to qualify for an exchange, the replacement must be of “like-kind” as the exchanged property. Basically, the properties have to be of the same nature. You can, for instance, replace an apartment with a duplex, but you cannot replace an apartment with agricultural equipment.
Investment or Business Property: You also need these properties to be investment or business properties. You cannot exchange personal property.
Greater or Equal Value: The net value of your replacement has to be greater than or equal to the value of the property you are exchanging. If it is of lesser value, you do not qualify for the tax deferment.
Deadline: You have 45 days to identify candidates for the replacement and 180 days to close on the new property.