If you own rental properties, you might want to sell one property and buy another that you can rent out. Perhaps you’d like a rental in a different area, or maybe you want to get into a different kind of rental property – move from residential properties to commercial properties, for example.
Since you’re using the property for business purposes, you’ll pay capital gains taxes on the proceeds when you sell – sometimes as much as 15 to 30 percent in state and federal taxes.
But did you know that there’s a way you can unload one property and get a new one without paying taxes? It’s called a “1031 exchange” after Section 1031 of the tax code. A 1031 exchange is a transaction that allows businesses and other eligible entities to exchange “like-kind” properties. Because neither seller receives any cash from the sales, the capital gains on the properties can be deferred until the properties are sold outright.
There are rules about the kinds of properties you can exchange. The property exchanged must be used for income, investment, or business purposes, and the definition of “like-kind” is broad. You don’t have to exchange a rental house for another rental house. The Balance lists a few kinds of transactions that would qualify for a 1031 exchange, including:
- Office building exchanged for a shopping center
- Land exchanged for an industrial building
- Shopping center exchanged for land
- Apartment building in exchange for a small office building
Some types of properties do not qualify, including:
- Personal homes
- Land under development
- Homes bought to be flipped
The exchange can happen simultaneously or you can delay the exchange, but be aware that a 1031 exchange has time restrictions. You must close on or identify the potential replacement property within 45 days from the closing and transfer of the original property. There are no exceptions, so be sure you’ll be able to find a replacement property before you initiate the original transaction. If you go over the 45-day limit, you can disqualify your exchange and owe taxes.
Once you’ve chosen a replacement property, you have 180 days to complete that settlement.
A 1031 exchange isn’t for new investors or DIY types. It is a complicated transaction, and you will need a professional help to navigate through the process. If you think a 1031 exchange is right for you and have questions, give Foote Title Group a call. We’d be happy to help you learn more about this unique type of real estate transaction.