In the world of real estate investment, unexpected occurrences can happen at any time, but odds will only turn in one’s favor if the necessary opportunities are leveraged well with the right tools. Now, while this saying may go in a multitude of ways, it is important to note that the one particular tool that it best applies towards is the 1031 exchange.
Often regarded as one of the greatest tools in the real estate market, 1031 exchanges are a law-bonded way to move and swap properties around easily without any associated drawbacks from mounting costs. As advantageous as this tool may be, one common hurdle associated with it is that many investors are facing the presence of capital gains taxes, and their ability to take a chunk out of one’s profit.
Fortunately, the idea of dealing with taxes when rolling out your exchanges on real estate doesn’t necessarily have to be as unavoidable as it may seem. This is where the concept of swapping until you drop comes in.
If you want to swap properties but are fearful of paying jaw-dropping fees, then here is a guide on avoiding them entirely.
Looking into the specifics
The task of avoiding hefty capital gains taxes on your next fortune-building swap, must first begin with a proper overview of the law so that you don’t end up with legal repercussions instead of profits.
According to Title 26 of Section 1031 in the Internal Revenue Code, guidelines dictate the following key piece of information:
“No gain or loss shall be recognized on the exchange of property held for productive use in a trade or business or for investment if such property is exchanged solely for property of like-kind which is to be held either for productive use in a trade or business or for investment.”
The main takeaway is that exchanging one property for another—whether it’s an office for office, land for land, or office for land exchange, etc—should not result in a gain or loss. Based on the text, it is important to note that you won’t be taxed or will be taxed minimally during the exchange, but will experience paying the capital gains tax once you offload the property.
Avoiding the capital gains tax
As intricate as it may sound, deferring any form of capital gains tax on your purchase or property by swapping can be easily done by following three requirements for like-kind exchanges, namely:
- You must be exchanging your own property for any other form of real estate
- The listing you’re selling must be a form of investment property and not your personal residence
- You must be exchanging properties with another party within the bounds of meeting set deadlines and timeframes.
On the other hand, it is important to note that there are a few limitations that dictate what you cannot use a 1031 exchange for:
- Stock in trade or other property held for resale
- Stocks, bonds, or notes
- Other securities or evidence of indebtedness or interest
- Interests in a partnership
- Certificates of trust or beneficial interests.
By incorrectly making a swap for the particular items mentioned above, you instantly nullify the duty-free nature of the exchange and will end up being charged for applicable capital gains tax.
When used correctly, a 1031 Like-Kind Exchange can easily be leveraged to the advantage of your real estate investment plans without incurring an overwhelming amount of Capital Gains Tax. By taking this quick guide to mind, you can attempt to maximize the return on your investments and essentially minimize your tax bill well enough work toward keeping your returns positive in the long run!
Interested in real estate investment the right way but don’t know where to start? Get in touch with us today to see how we can help!