When you sell your primary residence, you can make a non-taxable profit of $250,000 as a single person or $500,000 as a couple. When you have investment property, however, you have to be very careful how you structure things so as to minimize your tax liability resulting from the transaction. Section 1031 of the Internal Revenue Code lets you defer taxes on the gain you realize if you meet the guidelines specified in the Code, in letter rulings, and by their general practice. It can get tricky.
Don’t own income property? Have you rented your ex-primary residence for an extended period of time? You must have lived in it two of the past five years to get the tax-free treatment on your gain. If you don’t meet the criteria and are renting the property you have income property. If you want to transfer the equity, i.e. move your investments out of a state that doesn’t meet your values any more, you can do so and defer the taxes, including state taxes from the state you are leaving, if you execute your exchange right.
The first thing to do is make a plan. You can make an offer conditioned on the sale of your property, but you are stronger if you are already in escrow, or better yet, closed on your relinquished property. Unlike selling your primary residence, when you sell an investment property it can have tenants, or is vacant, but you aren’t on a time crunch to move. You will, however, be in a time crunch to identify your replacement property.
To safely complete a 1031 Exchange, you need to identify your replacement properties within 45 days after the close of escrow. The guidelines say you can select three properties of any value total, or any number of properties up to 200 percent of the value of the relinquished property. The latter is very difficult to achieve. The first is the most common in today’s delayed exchanges. Be careful when you identify and make sure that you can contract on the property you name. If you can’t contract you could blow the exchange.
After you make your initial plan with your exchange-knowledgeable agent, your exchange guide will be your accommodator, the representative from the company handling the exchange for you. They specialize in exchanges and are essential for keeping your exchange safe. There are many things that can happen along the way during the exchange process and we can’t stress enough how vital it is that you have the guidance of a professional. The benefits of an exchange are great, the consequences of an improperly executed exchange financially dire.
It is important that you understand the underlying guidelines of the exchange. You are not able to “control” the funds. In other words, the money goes from your sale to the accommodator and then to complete your sale. If there is a refund from the escrow because of pads, it doesn’t go to you, it goes back to the accommodator so you don’t control it. Little things can trip you up if you aren’t in experienced, knowledgeable hands.
Our advice: It is important to remember that the IRS gives you this opportunity to keep your investment funds invested without taxation, but never forget that they do everything they can to grab the tax anyway. You must comply or they will come for the money. Be sure your agent knows and understands 1031 Exchanges and that he connects you with a top notch exchange accommodator. That way, you can rest peacefully not wondering if you are going to have your exchange challenged.
Exchanges are a wonderful part of real estate that help investors grow their portfolio. You can do reverse exchanges, delayed exchanges, swaps, etc. Make a plan with your exchange-savvy agent and enjoy the benefits. It’s part of the game when you are in investment real estate. Ask your agent how it can work for you.
When it comes to choosing professionals to assist you with your real estate needs… Experience is Priceless! Jim Valentine, RE/MAX Realty Affiliates, 775-781-3704. dpwtigers@hotmail.com
