The real estate market is climbing fast. Over the last year alone, the average sales price increased by 17%.
That’s great news if you’re an investor. At least, that’s what it seems on the surface. If you want to sell a property, you’ll have to pay capital gains taxes on the profits. You could pay up to 20% of the profit in taxes.
That’s why investors leverage tools to minimize their taxes like a 1031 exchange. It’s legal, and in your case, it’s a smart move.
Are you interested to learn more about 1031 exchanges and how to pay less in capital gains taxes? Keep reading to learn the basics of a 1031 exchange.
What Is a 1031 Exchange?
Section 1031 of the tax code says that an investor or business can defer capital gains taxes when they sell one property and purchase a similar property.
You take the funds from the sale of one property and apply them toward the purchase of another property.
Note that this can’t be applied to residential property owners. You either have to be an investor or a business.
The other important note is that you can defer your taxes. You still have to pay them eventually, when you sell the new property. You could use 1031 exchanges for several properties, but most investors cash out eventually.
You’ll want to view more here for investment resources and other 1031 exchange tips.
The Rules of a 1031 Exchange
A 1031 exchange seems straightforward because you’re dealing with like-for-like properties. It’s not as simple as it seems.
There are a number of rules that you have to abide by in order to qualify for the tax benefits. The first is that you have to use a qualified intermediary to handle the transaction. That’s because if you handle the funds at any point in time, you have to pay capital gains taxes on them.
There is a 1031 exchange time limit. Investors have 45 days from the date of sale to identify a new property and 180 days to close on that property.
The qualified intermediary sends the appropriate paperwork to the IRS at each step. You have to stick to these deadlines. If you’re late, you miss out on the 1031 exchange benefits.
The rules of 1031 exchanges change from time to time. There’s a proposal on the table to limit the availability of 1031 exchanges. One proposal eliminates 1031 exchanges if the capital gains exceed $500,000.
You have to stay up to date on these and other changes to take full advantage of the opportunity.
Take Advantage of a Tax Exchange
A 1031 exchange is a legal tool that you can use to defer your capital gains taxes. There are a number of rules to follow to get the benefits from the tax code. You can use the tax deferment to grow your real estate empire.
Be sure to check out the Business and Finance section of this site for more investment tips!