Wouldn’t it be great if you could purchase a commercial income property, gain a cash on cash return, gain tax benefis and appreciation- and then sell without paying any taxes on your profit.
Believe it or not, thousands of real estate investment property owners do this on a daily basis, through something knows as a 1031 property. A 1031 property allows you to sell your profitable commercial investment property and delay the tax on capital gains, simply by purchasing another income property of equal or greater value.
Interested? Here are 5 rules you need to know before you consider purchasing a 1031 property:
RULE #1: YOU CANNOT PERFORM A 1031 EXCHANGE ON YOUR OWN
The IRS requires that you use a qualified intermediary, also called an accomodator, in order to carry out a 1031 exchange. Neither you or someone who represents you can perform the exchange. So your lawyer or your CPA would not be allowed to serve as an intermediary if they were your agent within the last 2 years.
RULE #2: YOU MUST BUY A PROPERTY WITHIN 45 DAYS OF SELLING
You have 45 days from the sale of your old property to identify the property or properties you plan on buying, even if the 45th day is on a Sunday or holiday.
The IRS does not allow extensions; a delay in finding a qualifying property or in completing the necessary paperwork could cost you a significant amount of money.
Also, the new property must be purchased within 180 days of the sale of the old property, or by the due date for your tax return (for the year in which the transfer of the old property took place) – whichever comes first.
You also need to give your intermediary a written list of the property or properties you are considering, along with the addresses and legal descriptions of each property. You may include up to three properties without regard to the total cost, and more than three properties if the combined value of all the properties is less than double the value of the property you sold.
RULE #3: YOU CAN EXCHANGE ANY PROPERTY FOR A SIMILAR PROPERTY
You can purchase any “like-kind” property within the U.S. and its possessions as long as both your old and your new properties are used in a:
- business or
- for investment purposes.
Plus, although properties need to be similar in nature, they don’t need to be the same in terms of grade or quality. That means that you can exchange unimproved property for a commercial income property, or exchange raw land for an apartment building.
RULE #4: YOUR PRIMARY RESIDENCE CANNOT COUNT AS A 1031 EXCHANGE PROPERTY
Not all property qualifies for a 1031 exchange. In addition to your primary residence, developed lots held primarily for sale, as well as property that is to be sold immediately after purchase or completion of improvements do not qualify as 1031 properties.
On the other hand, if a portion of the property is used for trade, investment, or business, that part alone may qualify for a 1031 exchange.
RULE #5: IN A 1031 PROPERTY TAXES ARE ONLY DEFERRED, NOT ELIMINATED
Since a 1031 property only defers taxes, once you sell the property you will be required to pay taxes. Plus, just as taxes are deferred, so are losses. If you had counting on uses those losses to offset large profits, you’ll need to carefully consider whether or not a 1031 exchange is your best choice.
1031 exchanges are a completely legal method for avoiding capital gains taxes, in addition to receiving passive income and diversifying your asset groups.
On the other hand, since there are numerous rules and regulations set out by the IRS, it is essential that you choose a qualified professional to help you carry out a 1031 exchange.