The IRS allows the sale of your primary residence to be free from taxes if you have lived there two out of the last five years and the profit is $500,00 or less for a married couple filing jointly or $250,000 if filing single. What many people do not know is that IRS Section 1031 in certain cases can allow an investor to sell a property then reinvest the proceeds in a like-kind property and defer the capital gains taxes.
There is no limit on the number of times you can do a 1031 and the code allows your investment to grow tax deferred. You are delaying the payment of taxes until the property is eventually sold. Those who pursue this strategy hope that when they sell the property they will be in a lower tax bracket and will pay less in capital gains taxes.
The 1031 exchange, also known as the Starker exchange, is only for investment and business property. There are some limited ways to swap vacation homes but the loophole is narrower and needs to be discussed with a professional well-versed in 1031 exchanges. Congress made major changes to the tax code in December of 2017 and from 1/1/18 forward real estate is the only type of property allowed for a 1031 exchange. The term like-kind encompasses many types of real estate. You can exchange similar properties and the rules regarding this can be somewhat complicated. In all cases the real estate must be in the United States.
It is rare for someone to have the exact property you want and you have the exact property they want. If this does occur, it is a swap and the deeds and exchange can occur at the same time. The majority of 1031 exchanges are delayed. In this case, a Qualified Intermediary needs to be hired. When you sell your current property, the proceeds are held by the intermediary until the closing of the replacement property. There are two important deadlines that need to be followed in this instance. Within 45 days of the sale, you must provide the intermediary in writing the specific property you want to acquire. You are allowed to designate up to three properties as long as you close on one of them. You must then also close on the acquired property within 180 days of the sale of the original property. These deadlines are strictly enforced and a gain will occur if not done correctly. You can also do a reverse exchange where you actually buy the property you want to acquire first then sell existing property to pay for the acquired purchase. The same deadlines are in effect for this transaction. Multiple properties can be used on either side of the exchange. For example, you may want to sell two rental properties to purchase an apartment building.
If you are interested in learning more about a 1031 exchange and how it would affect your taxes, please feel free to contact us. We can help you find an attorney who has done multiple 1031 exchanges; these transactions can be complicated and you want to make sure you do it correctly and do not incur any unexpected tax consequences.
Mike Sylvester, CPA/ABV, MBA