Real estate is a profitable niche if you know what you are doing. There are specific rules that you need to follow to avoid trouble with the law. Since large sums of money are at risk, you need to proceed carefully and become a sophisticated investor.
One of the complicated rules involving real estate is the tax-deferred exchange of properties. This means that you can postpone the taxes on the profit involving the sale of a property if you swap it to another. The 1031 term gets its name from the code from the IRS, which is famous because most realtors know this.
However, you can’t do as you please. There are certain requirements that you need to meet before using the 1031 exchange so everything goes smoothly. One of them is that you are only allowed to get like-kind properties, and there are limitations involving vacation houses. You also need to meet specific timeframes and more. Before everything else, here are some of the rules to know.
Guide in the 1031 Exchange
Like-kind exchange or also known as Starker, is the process of exchanging one property to another. Most of the swaps may be considered taxable by the IRS. But if you make it to the cut, you will either have only limited tax dues or none at all during the transaction.
As the IRS considers it, you can get another property without the need to consider cashing it out and making it your capital gains. You will be able to allow your investment to grow while deferring taxes at the same time.
An example is that when you are in the business selling cakes, and you own the building where the bakery is located, you can trade that shop to another one. Note that this does not apply to the home where you are living or your residence. Most tax laws repealed these kinds of exchange in 2018, so it’s better to consult a lawyer or a pro before getting into this. Read more about tax laws when you click here.
Most people have exchanged properties that they are utilizing in their business, and the important thing is that they own it. If you would like to take the opportunity to earn money with the 1031 exchanges, you can get more information from Delaware Statutory Trust Investment. These are the companies that can allow you to make the minimum investments needed to diversify your portfolio in the best possible way.
What Others Do
While most people make trade with their business properties, some get into this with their investment properties. The law in 1991 is still in effect, and it states explicitly that you can exchange your investment property to a like-kind one. For example, if you are out to sell a red duplex, you will be able to buy bare land or a warehouse that can produce income for you in the future.
There’s a warning that you need to heed, though. You need to know the special rules that apply to properties that depreciate over time. This can trigger some gains that can be termed as depreciation recapture in which you may be required to pay taxes. Generally, if you decide to swap your commercial building to another, you can avoid the depreciation recapture. Read more about this here: https://www.investopedia.com/terms/d/depreciationrecapture.asp.
There are also rules where you need a madman to delay an exchange. When you are selling, a qualified intermediary will hold the cash from the sale, and he will use it to buy the next property that you are aiming for. This is a process where the three-party exchange is considered as something similar to a swap.
You need to consider at least three properties and close one of them within 180 days. If the IRS states that you have passed some valuation tests, you can consider more than three. Within six months, you need to close everything to be able to get the tax-deferred benefits.
If you are considering using the new house as a vacation home, things can quickly get tricky. Most of the taxpayers may turn their vacation beach houses into rental properties and do exchanges. But this is something tricky where you need professional advice before you get into this.