When Does A Property Qualify For a 1031 Exchange?

If you’re considering a 1031 exchange it’s important to know if your investment real estate is eligible.

A 1031 exchange gives investors a way to defer paying tax on gain from the sale of investment real estate. This means that primary residences do not qualify for a 1031 exchange. A 1031 exchange is solely for real estate held for productive use in business, trade or for investment.

House flipping is also off limits. Section 1031 states that a property “held primarily for resale” does not qualify. This excludes fix and flips.

The good news is that like-kind, as defined by the IRS statute, allows for any type of investment real estate to be exchanged for any other kind of investment real estate. This means that if you’re selling a rental condo and want to use the proceeds of that sale to purchase a retail building, you are free to do so.

The power of a 1031 to shape your real estate investment portfolio using your own tax dollars is limited only by your creativity and desired outcome.

5 Advantages of Real Estate as an Investment

Real estate is a fantastic way to diversify your profile and build wealth. If you are weighing the pros and cons of investing in real estate here are five advantages of real estate as an investment.

1.   Tax Advantages

One of the most enticing aspects of real estate investing are the many tax advantages that come with it. For example, a 1031 allows you to completely defer capital gains taxes while you reinvest your proceeds.

2.   Rate of Return

When compared to other kinds of investments, real estate has a historically high ROI for owner-investors.

3.   Cash Flow

If you are looking for a way to generate passive income, rental properties are a great route to take. Once all the bills and maintenance fees have been paid, rental properties offer a stable and predictable source of cash flow.

4.   Protection against inflation

There is a reason investors call real estate a “Hedge against inflation”. While the price of coffee and gas shoot up and the dollar becomes worth less, your property is more than likely to continue growing in value. Real estate prices have historically increased at a faster rate than inflation has increased.

5.   Equity Buildup

The beautiful part of investing in a rental property is that your tenant is the one who is actually paying off your mortgage debt. Your equity grows immensely over time as your property appreciates and your mortgage is paid off from the rent you collect.

How Much Do I Need to Reinvest With a 1031?

When you begin hunting down replacement properties for your 45 day list, it is important to keep in mind how much you need to reinvest while carrying out a tax deferred exchange. The IRS has a two-part requirement laid out for reinvestment with a 1031. The first one is that in order to defer all taxes you must purchase at least as much as your “net sale”, the contract price minus closing costs or the total left before any mortgage is paid off. The second one is that you must use all the “net proceeds” in your next purchase. This means that if there was a mortgage, subtract the mortgage that was paid off and the difference is your net proceed.

If you choose to take cash out or purchase less than what you sold, the unused proceeds will become taxable to the IRS. The proceeds that were reinvested in your exchange will remain sheltered from capital gains tax. You have an immense amount of freedom when it comes to allocation of your proceeds. Just because you sold a single-family home, doesn’t mean that you need to reinvest in another single-family home. A 1031 is also not necessarily a one to one process, it is the valuations that are the key. If you want to sell a single property and reinvest in multiple properties, you have the power to do so. Just remember that if you wish to defer all capital gains tax you will need to make sure that your reinvestment uses all of your proceeds.

 

How the New Tax Plan Affects 1031 Exchanges

A 1031 exchange is the go-to process for anyone looking to maximize their real estate investing and defer capital gains taxes. But how will president Trump’s new “Tax Cuts and Jobs Act of 2017” impact 1031 exchanges?

In the past, a 1031 exchange could be used to defer capital gains taxes on both real estate and personal property. If you had a house with a bunch of furniture inside you could exchange both the house and the furniture without encountering any capital gains taxes. Under this new bill, personal property can no longer be exchanged using the 1031 method. However, if you were already in the process of exchanging personal property and had closed on a sale or acquired replacement property before December 31, 2017, then you are free to finish the exchange in 2018.

While these changes will have a big effect on art collectors, real estate investors will come out on top. Those looking to utilize the power of a 1031 exchange on their real estate are still free to do so.

If you want to see what else is covered in the “Tax Cuts and Jobs Act of 2017” follow this link to read the full tax plan.