Are you thinking about selling an investment property but aren’t sure what a 1031 Exchange is or how to do one. If so, check out my tips that will save you thousands of dollars in taxes.
1031 Tax Deferred Exchanges are one of the biggest benefits of real estate investing. This tax code allows you to sell a property today and defer taxes on the gains well into the future, thereby using those monies to purchase a larger property with a larger cash flow. 1031 Exchanges are one of the tools you have available to help you climb the Property Ladder and grow a portfolio that can generate enough passive income for you to retire on.
The key to a successful 1031 Exchange is to understand the rules that govern them. There are 3 key rules that you must follow and not run afoul of. If you don’t, you risk blowing your 1031 Exchange and having to pay the taxes today that you’ll owe on your gains.
The first rule is that you must replace debt with debt and equity with equity. This means that the total value of the mortgage on your new property, or replacement property as it’s called, must be equal to or greater than the mortgage on the property you sold. And, you must use all of the equity from the sale for the purchase of the replacement property.
Next, the proceeds, or funds, from your sale property must pass directly from your escrow company handling the sale straight to your accommodator. An accommodator is a 3rd Party Intermediary that will help you with the transaction and will escrow your funds for the time between when you close your sale property and when you complete the purchase of your replacement property. Remember, you can NEVER take possession of these funds, or you will void your exchange and have to pay taxes.
The final rule deals with timing. Within 45 days of the close of escrow of your sale property you must identify in writing to your accommodator what your anticipated replacement property is going to be. This is critical as it’s necessary to have on file in the event of a tax audit. And, you must complete your exchange within 180 days of the close of your sale property. This is also critical as it results in an invalid exchange if it doesn’t happen. It’s one of the easiest things for the IRS to monitor, so be careful with regards to your timing.
If you follow the above rules you’ll successfully complete your 1031 exchange and defer your tax bill sometime into the future. You can continue to do this from one property to the next over many years and even generations. Finally, make sure you speak with your accountant or tax professional before making a decision to sell. You want to be clear on the tax code and any other issues you may not be aware of.
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