Did you know that if you own a property that is not your primary residence, you are actually classified by the IRS as somewhat of an investor? This makes selling your property just a bit tricky, especially when it comes to the taxes which come along with it. In such cases, a large portion of your profit from the sale of the property is owned to the IRS, and is called a capital gains tax. Because of this capital gains tax, property owners are left with less profit when it comes time to sale their property.
If you want to avoid these capital gains losses, there’s a way to do so; using the 1031 exchange. Under Section 1031 of the United States Internal Revenue Code, property owners may exchange one property for another like-kind property and defer the recognition of capital gains or losses due upon sale. With proceeds from the sale being placed in escrow, property owners have 45 days to choose another property to re-invest their funds, and only 6 months to complete the transaction all together.
This can be very useful, especially in the investment of rental properties. Avoiding capital gains taxes will allow you to put more into your next investment. One of the misinterpreted rules of the 1031 exchange is the aspect that the properties to be exchanged must be exactly the same type of property. Although the rule is usually interpreted to be strict, it is actually very liberal. An apartment building could be exchanged for raw land as a 1031 exchange. There are still requisites, but they are more lenient than to be expected.
So when do you use a 1031 exchange? Often times, people will attempt to use it for second homes. However, the 1031 exchange is to be used with investment properties only. There are some loopholes that can take place to help you avoid capital gains taxes on vacation or second homes, though it is very difficult to achieve. Overall, it is wise to use a 1031 exchange when you plan to purchase another investment property… only then can avoid paying high capital gains taxes.
Talk with PMI to find out more about 1031 exchanges and how it can benefit you when it comes time to sell your property!