As a real estate investor, you need to be examining all of your options right now. With prices still low and poised to do nothing other than go up, it's time for you to invest in better properties. But you don't want to pay the taxes and repay the depreciation value on property that you will sell to bring in capital to buy a better investment property. The answer you need is probably a 1031 Exchange.

Title 26, section 1031 is the IRS tax code allowing investors to exchange one investment property for another of equal or higher value while deferring the taxes. The upside is having what would be paid in taxes available as capital to for the new investment.

You Pocket Nothing

One thing to consider carefully in a 1031 exchange is that you can't take any money for personal use from the sale. All of the proceeds from the sale must be reinvested into the new real estate investment. That's not to say that you can't take money out of the deal but if you do, the portion that is not reinvested in the new property will be taxed.

To assure the transaction happens in accordance with IRS rules, the IRS requires that all proceeds go through a Qualified Intermediary (QI). Another monetary requirement is that the amount of debt on the new property must be equal to or greater than the debt on the property being sold. If not, the investor is required to pay taxes on difference of the lower debt.

Time Lines

While there are multiple ways of structuring a 1031 Exchange, these are the required timelines for the most common method. The property to be acquired must be identified no more than 45 days after the original property is sold. The 45 days are absolute. Even if the 45th day falls on a weekend or holiday, the 1031 Exchange is nullified on the 46th calendar day. For that reason, several properties are often identified to insure that one can be closed on within the allowed time.

The 45 days is not the time allowed to close the deal. It is the time to identify the replacement property. You are allowed 180 days to close the deal on the new property. The 180-day rule has two elements. It is either 180 days after you transfer the old property to a new owner or 180 days after your taxes are due. Like the 45-day identification period, the 180-day acquisition period is absolute. Weekends and holidays count.
If you are considering improving your real estate investment during this opportune market, you should be considering a 1031 Exchange for deferred tax purposes. However, always consult a real estate or tax attorney before making any final decision.

 

About the author: Brian Kline has been investing in real estate for more than 30 years and writing about real estate investing for seven years. He also draws upon 25 plus years of business experience including 12 years as a manager at Boeing Aircraft Company. Brian currently lives at Lake Cushman, Washington. A vacation destination, a few short miles from a national forest in the Olympic Mountains with the Pacific Ocean a couple of miles in the opposite direction.