Who ever thanks the IRS? Seriously? Well, as unpopular as the IRS may be to most of us, there are tax deferred programs that can save real estate investors thousands of dollars. It does not matter if you own one rental or a dozen rental units or even more. Whether you are just getting started in real estate investing or are a seasoned investor, before your consider selling your rental properties, you should learn about and take advantage of what the 1031 Exchange has to offer.
Thanks to the Internal Revenue Code Section 1031, a properly structured 1031 exchange allows an investor to sell a property, to reinvest the proceeds from that sale into a new property (within a certain timeframe) and to defer all capital gain taxes. IRC Section 1031 (a)(1) states: “No gain or loss shall be recognized on the exchange of real property held for productive use in a trade or business or for investment, if such real property is exchanged solely for real property of like-kind which is to be held either for productive use in a trade or business or for investment.”
This scenario below helps to provide an illustration:
- A real estate investor (who is anyone who owns and leases a property to a tenant) decides he wants to cash out and sell his property. He assumes he'll earn about a $400,000 gross profit (before closing costs, taxes and commissions).
- He wants to move forward with the sale but learns that his $400,000 capital gain will incur a tax liability of approximately 35%, which includes federal capital gain tax, state capital gain tax, depreciation recapture and net investment income tax, when the property is sold.
- In other words about $140,000 of the $400,000 profit will go to taxes and only $260,000 in net equity remains to reinvest in another property (plus he will still have to pay closing cost and commissions out of his net proceeds).
- Fortunately his real estate agent tells him about the benefits of a 1031 Exchange, which when executed properly, allows him to roll over the gain, tax free into a new investment (rental) property of same or higher value.
- Assuming a 25% down on a new property, with a 75/25 loan to value ratio, this investor would be able to reinvest his entire gross equity of $400,000 in the purchase of $1,600,000 replacement property. All things similar, an investor who did not take advantage of the 1031 Exchange could only afford to invest in a $1,040,000 replacement property due to all the tax payments due.
This video produced by Asset Preservation, Inc. (API) will help you understand all you need to know about this process. API was founded in 1991 and is a recognized national leader in the 1031 Exchange qualified intermediary industry, having successfully completed over 175,000 IRC Section 1031 exchanges.
If you currently own a rental property or a business and were thinking about cashing out, this is a great financial tool to consider which could save you tens of thousands of dollars in taxes - - - perfectly legally! At LRA we have completed several 1031s and would be happy to help you understand the process. Since a 1031 Exchange does require a qualified intermediary, we would be happy to recommend a few firms to interview such as API or IPX1031. We also always recommend you speak to you CPA to ensure such a transaction makes sense for your situation.
If you would like to see real estate market data for Boulder County, there are plenty of statistics to check out in such as "Days on Market", "Total Inventory" and "Newly Listed Homes". We track all these market statistics for Single Family Homes (SFH) for most of neighboring towns on a monthly basis, including Louisville, Erie, Lafayette and Superior. Check out Winter 2017 market summary here. At Louisville Realty Associates, we have the experience, energy and depth of knowledge to help you list your home for the best price. You can reach me anytime at firstname.lastname@example.org.