What Everyone Should Know About 1031 Exchange

November 7th, 2006 categories: 1031 Exchange, Investor, Real Estate, Real Estate Tips

There are two things in life you can’t avoid…DEATH and TAXES.

Savvy investors have been able to avoid taxes when utilizing a 1031 Exchange. Every homeowner, when living in their primary residence for 2 out of 5 years has been able to avoid capital gains tax at least for the maximum per person which is $250,000 for each spouse (Section 121).

Let’s take this scenario which is feasible considering how many homeowners have paid off their homes…For instance if you have a home that sells for $600,000 and you and your spouse have lived in the house for over 2 years, you each get to keep $250,000 a piece for a total of $500,000 tax free, leaving $100,000 which would be taxed on capital gains of approximately $25,000.

What some homeowners have done is to rent that same house for 2 years and then sell the house as an investment. Now, the homeowner has the original exemption (Section 121) as well as deferring the excess gain over $500,000 which in this case was $100,000 as a 1031 exchange.

The key thing here is not rent longer than 2 years. The parameters are 2 out of 5 years as primary residence - very important detail that will make it or break it. As you can see, in this example the homeowner not only qualifies for the primary residence exemption (121) but also qualifies for investment deferral (1031).

There are strict tax guidelines when exercising a 1031 Exchange. The properties must be of like-kind. An investor may exchange 100% or do a partial exchange. The key note here is that an Exchange Company dealing with 1031 Exchanges must be used and contacted before the close of escrow on the investment property being sold.

The IRS provides a maximum of 180 days to complete an exchange. The time begins when on the date the investment property closed escrow. The replacement property must be identified (the property(s) that you wish to replace the sold one with) within 45 days and you must compete the purchase of the exchange with the new property within 180 days from the original close of escrow date. If this timeline is not adhered to then all the taxes will be paid.

For further information regarding 1031 Exchange Guidelines, the National Association of Realtors provides insight into some of the myths and further study.

Some answers to a few questions you may have are:

You need to own the property as an investment for 2 years in order to be eligible for a 1031 Exchange. There are some exceptions, see an Exchange Co or an attorney.
No you don’t have to reinvest all of the funds but whatever you don’t reinvest, you will be taxed on.
You can move into a rental that you have and use it as your primary residence but always keep in mind that the IRS will determine if you qualify for an exchange by looking at the intent that you had when you first purchased the investment.
Yes, you can purchase the replacement property first. This is called reverse exchange. There are guidelines that you must adhere to. Be sure to check with an exchange company prior to doing this.
Yes, you can sell a duplex and purchase bare land in a 1031 Exchange.

This entry was posted on Tuesday, November 7th, 2006 at 6:03 pm and is filed under 1031 Exchange, Investor, Real Estate, Real Estate Tips. You can follow any responses to this entry through the RSS 2.0 feed. You can leave a response, or trackback from your own site.

Christine said at November 14th, 2006 at 10:55 am
This is such a great topic to discuss. I am shocked to see or to hear just haow many people have no idea of this. (I ventured over here last week from the Tomato’s site) Congrats to you and MUCH success !!
Gena said at November 14th, 2006 at 7:28 pm
Yes, and they need to so hopefully every seller and investor will read it. It all boils down to that old adage that I continue to say many times over…you can take a horse to water but you can’t make them drink!
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