John and Natasha Karadsheh
It is no secret that real estate values have increased substantially over the past few years. While making money is a good thing, the resulting capital gains taxes are not as exciting.
For this reason, more and more investors are once again using the IRS 1031 exchange opportunity to maximize their investments and financial goals.
WHAT IS A 1031 EXCHANGE?
Section 1031 of the IRS tax code allows investors the opportunity to sell investment property and defer the capital gains from that sale by purchasing like-kind property.
The term like-kind is very broad, so, that means you could exchange an apartment complex for raw land, an office building for a strip mall, or simply one rental home for two others.
To maximize the tax benefit, the price of the new property must be greater or equal to the price of the old property (for maximum tax savings) and the amount of debt held on the new property must also be greater or equal than the debt held on the previous property.
EXAMPLE OF A 1031 EXCHANGE
You purchased a piece of raw land in Montana for $250,000 and you sold it several years later for $500,000. You are now subject to paying capital gains on your $250,000 of profit, which would be around $75,000.
Using a 1031 exchange, you instead use the $500,000 in proceeds to purchase two rental properties in Arizona valued at $250,000 each. The capital gains tax was deferred and the rental properties offer monthly cash flow in a way that the raw land did not.
COMMON REASONS INVESTORS UTILIZE 1031 EXCHANGES
- Defer taxes
- Diversify or consolidate real estate holdings
- Switch property types or move from one market to another
- Increase purchasing power and return on investment
- Improve cash flow
- Estate plan for heirs
- Reset the depreciation clock
IMPORTANT THINGS TO KNOW ABOUT 1031 EXCHANGES
1031 exchanges are only for investment and business property, and cannot be used to swap your primary residence for another home.
When the new tax legislation was being drafted in 2017, there was some discussion surrounding the elimination of 1031 exchanges altogether. While this did not happen, exchanges of personal property (aircraft, cars, franchise licenses) no longer qualify. Under the new law, only real estate qualifies.
Research and hire a Qualified Intermediary (QI) to assist with the exchange. A QI is a person or company that agrees to facilitate the 1031 exchange by holding the funds involved in the transaction until they can be transferred to the seller of the replacement property. These intermediaries are not federally regulated, so it is not advisable to just pick one from the Internet. Please do your research or call us for recommendations.
There are two critical and non-negotiable deadlines in a 1031 exchange. From the day that you transfer ownership of a property, you have 45 calendar days in which to identify a replacement property and then an additional 135 calendar days in which to close on that replacement property (180 calendar days total). If you don’t adhere to these specific timeframes, you will not qualify for the tax deferment. It can be a challenge to secure property in a tight market, so it is important to have a strategy prior to even considering a 1031 exchange.
Seek advice from your financial planner, tax attorney, and CPA relating to your specific tax and investment goals, and personal situation. Make a plan before you start the process.
Over the years we have done hundreds of transactions for large and small investors, and have great resources available to our clients. If you are thinking of selling your investment property, give us a call today at (480) 568-8680, and we can help give you a complete market valuation so you can plan your next investing steps.
KOR Properties and its agents do not provide tax, legal or accounting advice. This material has been prepared for informational purposes only, and is not intended to provide, and should not be relied on for, tax, legal or accounting advice. You should consult your own tax, legal and accounting advisors before engaging in any transaction.
John and Natascha Karadsheh are co-owners of KOR Properties. John has been a Multi-Million Dollar producing agent for over 17 years and is an Accredited Buyers Representative (ABR) and a Certified Residential Specialist (CRS). Natascha is a graduate of Princeton University and the Chairwoman of the City of Mesa Economic Development Advisory Board. You can reach John at (602) 615-0843 and Natascha at (602) 909-4995, or visit their website at KORproperties.com.
KOR Properties is a boutique real estate brokerage serving the Valley of the Sun, and the creator and founding sponsor of Mesa Food Truck Fridays.