The #1 Way to Defer Capital Gains Tax on Sold Properties

Section 1031: 

The IRS tax code, section 1031, commonly known among investors and real estate agents as a 1031 exchange, allows property investors to defer the capital gains of sold investment properties, which frees up money, allowing them to revinest into a like-kind property, or properties. 

Property Requirements of the 1031 Exchange: 

The 1031 exchange only pertains to investment properties, properties that are purchased with the purpose of personal, residential occupancy cannot be exchanged through a 1031. To qualify for a 1031 exchange, the property being purchased must be held for the same use, usually defined as for trade or business investment. Although the tax code states the exchanged property must be like-kind, the definition is very broad. Below are a few properties that would be considered suitable for a 1031 Exchange: 

  • Vacant Land 
  • Office Buildings 
  • Duplexes
  • Apartment Buildings 
  • Single Family Homes (used as a rental property) 
  • Warehouses 
  • Etc.

Examples of Non-Like-Kind properties: 

  • Primary Residence
  • “Flips” 
  • Stocks, Bonds, Notes, Mortgages, etc. 
  • Inventory and interests in a partnership

Rules of 1031 Exchange: 

Properties being acquired through a 1031 Exchange can be located anywhere in the United States. Investors can also sell or acquire more than one property in order to meet the financial terms necessary to avoid paying capital gains tax. If an investor acquires a property through the 1031 Exchange and it is priced to be less than the sold property, he or she is required to pay capital gains tax on the “boot” aka the money that is not reinvested into a new like-kind property. 

45 and 180 Day Rule: 

45 Day Identification Period – From the day the property is sold, the investor has 45 days to identify a like-kind property and put into writing their intention to purchase it.

  • They are allowed to identify up to three properties, however, they are only obligated to purchase one of the three. 
  • If necessary, the investor may identify more than three properties, but the combined fair market value cannot exceed more than 200% the fair market value of the properties they are selling. 

180 Day Exchange Period – (This 180 period runs simultaneously with the 45 days) An investor has 180 days to legally purchase and acquire the property. 

If either of these deadlines are not met, the investor will be required to pay capital gains tax for his or her sold property.  

Why would an investor choose to sell/acquire a property through a 1031 Exchange?
  • They are looking for a property with a better ROI
  • They are looking to diversify their assets 
  • Their property has appreciated in value
  • They are looking for a property with a management company already in place, relieving themselves of the responsibility 
  • They are able to defer taxes 
  • They are able to consolidate or relocate investment properties, if needed 

The 1031 Exchange is a great benefit to long term investors , however there are strict rules and regulations that can easily be looked passed. As an investor, it is important to work with an agent who is knowledgeable and has experience in a 1031 Exchange transaction.