As a real estate investor, it’s generally a good idea to find ways to maximize your profits in the most efficient and effective manner possible. Some investors opt to use what’s known as a 1031 exchange as they build and finetune their portfolios to meet their goals.
A 1031 exchange is a tool that many real estate investors use because it enables them to defer capital gains if they sell one property in order to purchase a different one. If you’ve never heard of this arrangement, consider the following information and use it to make more informed decisions about your options as you move forward.
A 1031 exchange authorized by the Internal Revenue Code
A 1031 exchange is named after Section 1031 of the Internal Revenue Code. It only applies to real estate transactions and can only include like-kind properties. This definition is based on the Internal Revenue Service’s definition of a “like-kind” exchange, which means the properties are similar in nature, even if they differ in type or location.
For example, if you sell a rental home and buy another rental property, a 1031 exchange allows you to put off paying the capital gains taxes that would normally be due on the sale. Instead of paying taxes now, you would reinvest all your profits into the new property, allowing your investment to grow while otherwise applicable taxes are deferred.
Strict rules govern 1031 exchanges
Specific rules must be followed strictly if you want to take advantage of a 1031 exchange. First, both any applicable property you sell and the one you buy must be held for business or investment purposes. There can’t be any indication that they’ll be used for personal purposes.
You’ll also have to find the new property that you want to purchase within the 45 days immediately following the sale of the old one. You must close on the new one in 180 days. A qualified intermediary has to hold the sale proceeds and until they’re used to buy the new property.
A 1031 exchange is a viable option if you’re trying to grow your portfolio through a legally valid strategy to defer taxes. Working with legal professionals who can help you to take steps to comply with all the requirements for these exchanges may take some of the stress and risk out of the process.
