It’s time to sell but how to avoid problem tax liabilities from your profits? If you are planning on reinvesting your properties into a new investment, you are in luck. IRS tax law, specifically a “Section 1031 Tax Deferred Exchange,” allows you to legally stave off the taxman. Does your property qualify for a Section 1031? Let’s see how it works.
A tax-deferred exchange allows investors to sell a piece of investment property, and quickly reinvest the proceeds for “like-kind” property. The new property is seen as a continuation of the original investment, so taxes are not due at the time of the sale. When you sell the next property taxes would then be due unless you do another 1031 Exchange, of course!
The requirements for your present investment property are fairly straightforward you will have bought and held the property in such a way that it is considered an investment as opposed to speculation. Generally holding a property for at least 18-24 months is considered the minimum for considering a Section 1031 Exchange. So if you have held the investment property for a shorter time you probably aren’t eligible. The law works this way because the government wants to reward long-term investment not speculation.
So the first part the property you are selling, is fairly simple. Hold it long enough and it qualifies. How about the property you want to “exchange” for? That is more complicated.
Within 45 days of selling your original property you must file a document identifying your exchange property. The new property (or properties) must be “Like Kind” which means they must be of a similar investment type. You can’t sell an apartment building to invest in a Rembrandt Masterpiece, say. But you can sell a duplex to buy an 8-unit industrial building.
The maximum number of replacement properties that you may identify is three properties. You also may identify any number of properties provided that the total value of these properties is not more than 200% of the value of the original property you are selling. You don’t have to close on all the properties you identify. You can name several if you’re not sure what will close, or not close, as long as the properties you actually close on meet the requirements of the exchange.
You have 180 days after the date you transferred the property you are relinquishing or after the due date of your IRS tax return (including extensions) for the year in which you made the transfer. For multiple property transfers, the 45-day identification period and the 180-day exchange period are determined by the earliest date a property is transferred.
So the key points for the new property is it must be like kind, and you must be able to close on the purchase within the time you have for the 1031 Exchange to be legal. It is normally the timing that is the most difficult consideration. If you can’t close within the required timeframe there are no extensions, and you will have to pony up to the IRS come tax time.
Despite the strict requirements for the properties and transactions doing a 1031 Exchange is well worth it. It can defer thousands of dollars of taxes far into the future. It is a great management tool for savvy investors to grow their portfolio.