Selling a home that you purchased for a considerably lesser amount means you’re making money. That’s a great thing until Uncle Sam wants his share. While there are some tax exemptions on capital gains on a personal residence, there is another option. How to use a 1031 Exchange to acquire property in Middletown, Dayton, or Cincinnati could allow you to move gains from one property to another without paying the tax man.
Avoiding Capital Gains for Now
A 1031 Exchange is used for investment real estate transactions to avoid paying capital gains on the sale. This is beneficial when you have seen a significant appreciation of the asset. The IRS actually looks at 1031 Exchanges beyond real estate property; in fact, all business assets include prize animals such as racing horses are eligible for exchange. That being said, when one asset is being exchanged for another, both assets must be the same type of asset.
So while you might not try to exchange an apartment building for a Kentucky Derby horse, you might try to exchange your home for an apartment building. You can’t do this because the 1031 Exchange only applies to business assets. Don’t worry about the residential unit if you lived in it for at least two of the previous five years prior to selling; you get a $250,000 capital gains exemption.
Interchangeable real estate properties used in 1031 Exchanges include rental single family homes, duplexes, condos, apartment buildings and commercial property. Use the 1031 Exchange to take a full set of assets from one property to transfer into another without worrying about losing any money to taxes. It maximizes your equity position.
Types of 1031 Exchanges
There are four types of 1031 Exchanges: simultaneous, delayed, reverse, and construction exchanges. A simultaneous exchange is when the sale and purchase happen on the same day. While it is possible for parties to “swap” deeds, most transactions use a third-party escrow company to facilitate the entire transaction to ensure all rules are followed. The delayed exchange is more common where a seller relinquishes the first property and later purchases the new like-kind property.
A reverse exchange buys one property first and then sells the relinquished property. This is only available to all cash buyers who don’t need to sale proceeds to get another property. Construction exchanges are done when an investment property has been developed or significantly improved.
1031 Exchange Rules
You already know it needs to be a like-kind investment property. The transaction must benefit the same taxpayer, meaning it must stay in the same LLC or using the same Social Security Number. The new property must be of the same value or higher than the existing property. You have 45 days to identify a new property in a delayed exchange and 180 days to complete the new purchase transaction otherwise the exchange is void.
Make sure you are following the rules. If you are unsure of the process, find an escrow company that understands the 1031 Exchange process. They are pros at making sure you meet deadlines and follow all regulations. Don’t assume that you can just state the 1031 Exchange on the tax returns and be in compliance. Get the help you need.