With tax time in the rearview mirror, as a real estate investor, you’re probably looking for ways to combat next year’s tax bill using rental property tax benefits. Did you know that taking advantage of the 1031 Exchange can help you expand your rental property portfolio without being penalized for tapping into the unrealized profits from the property’s appreciation.
Disclaimer: always review your specific situation with your CPA or tax attorney.
What is a 1031 Exchange?
Named after Section 1031 of the Internal Revenue Code, a 1031 Exchange lets you defer capital gains taxes by selling one investment property and using the funds towards another one (or more) investment properties. It’s sometimes referred to as the Starker loophole.
The proceeds from the sale of one investment property can be used to reinvest into one or many others. However, they will need to stay of like kind. Think, residential to residential or commercial to commercial. Sorry, you cannot use the 1031 exchange to buy or sell personal residences. The Internal Revenue Services also places strict limits on vacation homes.
You also cannot trade any stocks, bonds, partnership shares, certificates of trust and other items. In addition, you can’t trade investment property for personal residences, foreign property, or “stock in trade.”
Until you sell for cash years later, you can avoid paying the capital gains tax. If you plan accordingly, you’ll only have to pay one tax at a long-term capital gains rate. These rates are currently 15-20%, contingent on your income.
How Does the 1031 Exchange Work?
The beauty of a 1031 exchange is that there are no limits to how frequently you can use it. You can roll the gain over from one piece of real estate investment to another and so on. But you have to take certain steps.
For starters, you’ll need to select a qualified intermediary to administer the exchange. The intermediary party that will temporarily hold the sale funds from the relinquished property, pending the purchase of your replacement property.
The intermediary must be an independent party, so your attorney, personal accountant, or investment advisor cannot serve as intermediary. Your attorney can help you select one though.
While your attorney will ensure you follow all applicable governing tax regulations, including adhering to the strict timelines. This includes the 45- and 180-Day Rules.
45- and 180-Day Rules
45-Day Rule
The 45-Day Rule applies to the designation of replacement property. So, once the sale of your property happens, the intermediary will receive the proceeds. You have 45 days from the sale of the property to designate a replacement property(s).
This must be done in writing to the intermediary. It must state and specify the property you’d like to acquire. You cannot receive the cash yourself. Again, your attorney will oversee this to ensure adherence to the timeline and regulations.
180-Day Rule
Next is the 180-Day Rule. This timing rule relates to a delayed exchange of closing. The new property must be closed within 180 days from the sale of the previously owned property.
The Bottom Line
Followed properly, the 1031 exchange in Orlando, Florida, helps you free up more capital and continue to reinvest in new rental opportunities. Ultimately, you have to decide what types of investments make sense for your portfolio and objectives.
The Realty Medics is well-versed in utilizing the 1031 Exchange with our clients. We can connect you with reputable Central Florida real estate attorneys to help meet your investing goals. Call us at 321-947-7653 or complete our online Contact Us form to learn more.
