The 1031 exchange can be a powerful tool. We are going to help you determine what it is, and help you decide if you should use it for your real estate investment strategy.
What is the 1031 exchange?
1031 exchange is defined by the IRS as “when you exchange real property used for business or held as an investment solely for other business or investment property that is the same type or ‘like-kind.’” The government provides the 1031 exchange as a way to “defer/postpone” those taxes for a later time and you could possibly differ them forever. You can do this over and over just keep in mind someday you will have to pay those taxes and that the tax bill will add up but so will your wealth. You could continue to defer capital gains until death, eventually avoiding them altogether.
What is capital gains tax?
Capital assets are investments such as real estate, mutual funds, bonds, fine art, etc. A capital gain is a profit made from the sale of any capital asset where the sales price exceeds the cost of the investment. So capital gains tax is a levy assessed on the positive difference between what you pay and what you sell it for. The rates are 0%, 15%, or 20%, depending on your tax bracket.
By now you have realized the 1031 exchange can be a great wealth-building tool but there are a few things you need to know before you decide to use it as a strategy. The 1031 comes with a couple of rules. The first rule is the 1031 exchange is only applicable for Investment or business property, not for personal properties. The second rule is the net market value and equity of the property purchased must be the same as, or greater value than the property sold. The third rule is you only have 45 days to identify to find up to three potential properties and then you must close on at least one of them within 180 days of selling the initial timeline. This might be the most difficult part for some investors.
The 1031 exchange can help you increase your portfolio. It can be a great tax-deferred strategy to build wealth but you need to have good real estate knowledge and really understand the 1031.
1031 Exchange & COVID-19
The IRS issued a notice providing taxpayers who are currently engaged in a 1031 exchange relief from the 45-day identification period and 180-day exchange period deadlines.