Unless you’re a CPA, it is unlikely that you have spent enough time studying all of the tax law to understand what it could mean for your bottom line. However, a 1031 exchange is something that you should know about.
1031 refers to that specific section of the Internal Revenue Service’s Code. Section 1031 is related to the taxes on the sale of the property, which people typically are responsible for paying when they sell. However, the 1031 exchange is a special tax deferral program that can help you hold on to more of your hard-earned dollars. This exchange works by being able to sell a piece of property, and then take that profit and turn around and reinvest it into another property. This helps you to bring more cash in hand to your next purchase and can have an effect on the capital gains taxes you would pay in that year.
However, there are several factors to consider carefully before you decide that a 1031 exchange is the right path for you. If you fall outside of any of the rules, you may find that you inadvertently disqualified yourself from this great program. At SellTaxFree.com, we want to make sure that you keep more money from every real estate transaction you make.
Capital Gains Taxes
Capital gains taxes are any taxes that are specifically related to selling items that you made money on. While this does not apply to most everyday purchases, it is critical for business owners and private homeowners or real estate developers to understand this. In addition to real estate, capital gains are also commonly seen in stocks, vehicle sales, or other marketable items.
Real estate transactions can often be specifically tricky because the gains made on a property can end up pushing an individual into a higher tax bracket. This can cause them to pay even more money in taxes on all of that income. Fortunately, if you take advantage of the 1031 exchange, you can avoid a huge tax bill when next April rolls around.
Some Rules of a 1031 Exchange
Unfortunately, not every person selling a piece of property will qualify for the 1031 exchange. The IRS requires that the property be held for investment or business purposes. This means that if you sell your primary residence, you will not qualify for the exchange.
In order to prove that the property is an investment, you will be required to submit many pieces of documentation. This includes associated tax returns, rental income, your records that document depreciation, and sometimes a letter of intent that is linked to the property. While these documents may not be required, you should ensure that you have everything in order and stored correctly in the event of an audit.
In addition to having the sale adequately arranged, you also need to ensure that the purchase follows some guidelines. First, the piece of property that you are acquiring must be equal to or greater than the value of the property that was sold.
There are also some specific timing deadlines. The first is a notification to the IRS about the purchasing plan within 45 days of the exchange. This notification should include all of the properties that are planning to be purchased within the exchange. The list cannot be changed after 45 days, and the purchased property must be located on that list. The new property must also be bought within 180 days of the close of escrow on the sold property. The 45- and 180-day timeframes run concurrently, so make sure you keep them both in mind.