If you hold real estate in your portfolio, you may hit a point where you would like to sell one property to raise funds for a different opportunity; yet you’re dreading the tax bill you may face because the first property has appreciated in value. But through a 1031 exchange, you can defer your tax expenses by swapping proceeds from the sale of one investment property directly into another.
How 1031 Exchanges Work
Named for Section 1031 of the tax code, this exchange allows a property owner to sell an investment or business property and then use the proceeds to acquire a similar property, thus deferring paying taxes on the gains in the property value. 1031 exchanges are popular for real estate investors looking to purchase larger investment properties or enter new real estate markets, but who need to sell an existing property in their portfolio first to do so.
Note you have to follow IRS rules closely in order for a 1031 exchange to be valid. A real estate owner must identify in writing or close on a transfer property within 45 days of the sale of the original property. Then the owner must close on the new replacement property within 180 days after finding the replacement property was selected. The real estate investor cannot take possession of the funds from the sale of the first property, which means a qualified intermediary acts as a substitute seller of the first property, acquires the new property at closing, and then transfers that second property to the real estate investor.
1031 exchanges used to hold more strict regulations requiring the two assets in a 1031 exchange to be very similar (e.g., an apartment building could only be exchanged for another apartment building). However, the restrictions have since been eased and you can generally do an exchange between different types of properties if both are intended for investment purposes. So an exchange of an apartment complex for an office building would be allowed.
Note that primary residences aren’t eligible for a 1031 exchange, nor are most vacation homes that aren’t used primarily as rental properties.
You can do an unlimited number of 1031 exchanges throughout your life. Although you may make a profit on each property you swap, you will avoid paying taxes until and if you choose to sell a property for cash.
1031 exchanges can also be an estate planning tool to limit the tax bill your heirs may face. If, when you pass away, you leave to your heirs property that you acquired through a 1031 exchange, the value of that property will be set at the fair market value for the property, eliminating the need to pay taxes on any appreciation of that asset, or the properties held in previous 1031 exchanges.
Making Wise Real Estate Investing Decisions
Executing a 1031 exchange can be a great way to help defer taxes, but it includes a lot of moving parts. That’s why it’s best to work with an experienced professional. We can help guide you through your real estate transactions and help you consider how real estate investment can fit with your overall portfolio and goals. Contact us at (626) 529-8347 or email Ricky directly at firstname.lastname@example.org.
About Haydel, Biel & Associates
Haydel, Biel & Associates is an independent financial advisory firm serving individuals and families near Pasadena, California. The firm was founded in 2004 by Chris Haydel and Ricky Biel with a desire to provide unbiased, client-centered, community-based financial advice. Together, they have built a practice that has grown into a family of caring, smart professionals committed to blending proven investment methodologies with creative financial technologies that make it easier than ever to accomplish your goals. They strive to keep things simple and fun to give their clients peace of mind and alleviate financial stress. HBA Wealth takes care of their clients’ needs first and foremost and goes the extra mile to make their clients’ finances grow. To meet and see how the HBA Wealth team may be able to help, contact them today at (626) 529-8347 or email Ricky directly at email@example.com.
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