Owning homes, second homes, vacation rentals, investment properties, and other forms of real estate can be an incredibly rewarding investment into your future. But there are a lot of complex legal processes that go along with owning real estate, and if you’re inexperienced with investments, you can end up losing a lot of your profits in a sale. Recently, I have saved several of my clients from losing BIG MONEY on transactions by using a 1031 Exchange. But what does a 1031 Exchange mean? If you want to learn how to get the most “bang for your buck” in real estate sales, keep reading and I will tell you all about this awesome tool for property sellers and buyers.
If you’ve been looking into selling your home, vacation home, or investment property, you’ve probably come across an inconvenient obstacle: capital gains tax. Or maybe you haven’t! I could tell you so many stories I have heard of people who were so excited about the profits earned on a long-term investment property sale, and then they get hit with the surprise that they are required to pay a huge amount of capital gains tax on their investment. If you aren’t familiar with real estate taxes and property laws, this blog post is for you.
What Is Capital Gains Tax?
Capital gains tax is a tax that you are required to pay on any profits earned from a capital asset. This means if you purchased a home and it has significantly appreciated in value your home could be subject to a capital gains tax after it is sold. The good news for homeowners is that if you’ve occupied your home for two of the last five years as a primary residence you are exempt from these taxations, so most people selling a home aren’t going to be subject to capital gains tax.
Where capital gains taxes will hit hard is in the sale of a second home, vacation home, or investment property.
Maybe you’re looking to increase your investment portfolio. Maybe you’ve outgrown your current vacation home. Or maybe you have a rental property that you’d like to sell to the current tenants in order to purchase another property in a different area. Whatever the case, you need to know the answer to this question: What does a 1031 exchange mean? And how does it work?
Short answer: it means you can avoid capital gains taxes on the profits you’re making from selling your capital asset (land, second home, vacation home, investment property, etc.) in exchange for another one.
But there’s a little more to it than that, so keep on reading!
What Does A 1031 Exchange Mean?
A 1031 Exchange is essentially a swap of one property or investment for another. But these properties must be of “like-kind,” predominantly for business or investment purposes.
A 1031 Exchange is essentially a swap of one property or investment for another. But these properties must be of “like-kind,” predominantly for business or investment purposes.
A 1031 Exchange can be extremely beneficial not only because it allows you to defer your capital gains tax, but also allows for your investment to continue to grow. And the best part is there is no limit to how frequently you can do a 1031 Exchange as long as your property swap falls under the regulations of a 1031. This means that you can defer capital gains tax several times, potentially profiting off of each property swap, until you are ready to sell your investment for cash years later!
Important Things To Note About A 1031 Exchange
In a traditional 1031 Exchange, you would be swapping your property with another property that is like-kind. This transaction would take place between two buyers who want to simply switch properties. But, as you can imagine, finding someone who wants the exact property you are selling who can also provide you with the exact property you’re looking for is like finding a unicorn. Which means 1031 Exchanges usually involve a third party or a delayed exchange. During a delayed exchange you will also need an intermediary to hold the funds of your sale until you’re ready to purchase your new property.
But it’s important to note that there are very strict rules on the timelines of a 1031 Exchange. In a delayed Exchange, you must designate the property you would like to acquire with your intermediary within 45 days of the sale of your original property, and you must be able to close on the new property within 180 days of the sale of your original property.
The rules and structure for these exchanges can be complex in other areas as well, including depreciable property, reverse exchanges, and vacation properties, which is why we always recommend you work with an agent if you’re interested in doing a 1031 Exchange.
So what does a 1031 Exchange mean for you? It could be the difference between a huge influx to your net worth, or it could mean a sizable tax payment! Are you wondering if a 1031 Exchange is the right move for you? I am always happy to sit down with you and – with no obligation whatsoever – help you come up with a plan for your future investment strategy. My goal is to serve the Rogue Valley (and beyond) with exceptional care that goes above and beyond real estate. When you succeed, I succeed. So let’s succeed together!