The 1031 exchange is a technique that allows real estate investors to sell their investment properties and parley the profits into their next acquisition tax free. Well, perhaps it is more accurately described as "tax deferred". There are many rules that you must follow in order for the 1031 exchange to be allowed by the IRS, but when you handle all the details correctly, you can build wealth much faster by avoiding capital gains tax, depreciation recapture, state taxes (in certain states) and for some taxpayers, the new 3.8% ObamaCare tax. You're about to discover the ins and outs of the 1031 exchange so that you can decide how and when to employ this tax saving technique to your own investments.
Here is a summary of what you learned in the video above:
1031 Exchange: Tax Free Real Estate Investing
The 1031 Exchange is a section of the US tax code which describes how a real estate investor can buy a piece of real estate for intent of investing and resell in a few years without having the money they gained from the sell taxed as long as they reinvest it. It would be as if you bought a house for 80,000 and after a few years, you sold it for 100,000. So you have a gain of $20,000 that can have some significant taxes hitting it. There’s a capital gains tax, depreciation recapture taxes, local taxes, and possibly the Obama tax depending on your income. If your whole intent in selling the house was to reinvest the money, With the 1031 Exchange you can take the complete $20,000 and put it towards a new investment without paying any taxes on it.
The intent must be for RENTAL properties, not for flipping houses.
Net Selling Price
If you bought a house for $80,000 but are now selling it for $100,000 the new investment you want to apply the gain towards must be at least $100,000 or bigger. It can be multiple properties that are less than the $100,000 but the total amount must be at least $100,000 or bigger.
Identify the Properties
You have 45 days to identify the property you want to buy and then close the deal within 180 days. If you do not close within 180 days they will send the gain money to you and then you will have to pay the taxes on it.
Your Intent and Length of Ownership
Length of Ownership needs to be at least two years in order to be considered “safe harbor”
Intent to rent out properties
Same Tax Payer
You cannot buy and sell with partners. If you own the money, then when you go to buy the new property, it must be in the same name.
- Get the property you are selling under contract with a new buyer
- Identify the Intermediary
- Intermediary will approve the HUD closing statement
- Money goes into an Escrow Account
- Identifying Period 45 days
- Closing Period: 180 days
Quick Tip Example:
- Bought a property for $80,000 Cash
- Put $10,000 worth of Rehab into it
- If you want to do a 1031 Exchange then create your own Mortgage with you as the borrower
- So that at the HUD closing it will show a $90,000 payoff to you
- Technically you do not want that money in Escrow so in order to get paid on the closing statement you make your own mortgage.
What if you identify the property you want to buy before you have a contract on the property you want to sell?
Reverse 1031: The property is purchased first in the name of the EAT (Exchange Accommodation Title Holder.) You must have the cash and loan to buy it, then sell your property, and the proceeds on what you already purchased will go over to the new property.
The vision and the reason why the 1031 is such a valuable tool is because you can take a rental property and sell it, then take the proceeds to your next investment, refinance, and do this again with an even bigger property. It is long-term wealth building. Take advantage of this if you are planning on or already own rental property.