Your real estate business can grow from very small and humble beginnings to an unlimited size and source of income. The key to that growth is deciding what action you will take when the time comes to cash out or reinvest. I share and teach the most profitable investment methods that I’ve mastered in my many years as a successful investor. Among these methods are:
- Sandwich Lease Options
- Cooperative Lease Options
- Wealth Building Arsenal
- Working With Realtors
- Subject To – Get the Deed
Every one of these is proven to help you run and grow your business. As your business prospers, a time comes to cash out or reinvest your profits. In this previous post, I shared with you some important factors you want to consider when making this important decision.
This cash out or reinvest post is about how you can minimize the taxes owed on your profits using the IRS 1031 Exchange.
Avoid Paying Capital Gains with a 1031 Exchange
Every investor should know about the IRS tax code 1031 exchange (1031 is the tax code section if you want to look it up). This part of the tax code allows you to sell one investment property to purchase a higher cost (more profitable) investment without paying capital gains taxes and depreciation recapture taxes. The 1031 exchange can be used in many ways such as selling a property and taking part of the profit out. But when most of the profit is rolled over into a new investment, you can defer taxes on the amount that is rolled over.
This can be a great way of building a financial legacy for you and your family. You’ll definitely want to seek out the advice of a highly qualified 1031 tax expert but there are ways of combining a 1031 exchange with a trust so that you pass on investment properties to your heirs practically tax free. Your heirs can continue building your investment business without seeing it crippled by high taxes. This is a secret to how the ultra-rich keep their wealth.
Key Steps in the 1031 Exchange
There’s no doubt that the 1031 exchange rules can be complicated. Below is the basic process but there are a half dozen or more variations. Some allow you to buy the replacement property before selling your current investment. Other methods allow you to sell first and then buy the replacement property. You will find a method to improve your investment holdings without paying capital gains or depreciation taxes on sold properties.
Here is the basic process.
- Properties qualifying for a 1031 exchange must be for business use or investment (“productive use” as phrased by the IRS).
- The replacement property must be of “like-kind” (which is generously interpreted by the IRS).
- A qualified intermediary is required.
- The investor cannot have constructive receipt of tax deferred sale proceeds at any time.
- The 45-day identification period and 180-day closing requirements must be met.
- The price of the replacement property must be equal to or greater than the relinquished property.
- The amount of mortgage on the replacement property must equal or exceed that on the relinquished property.
- All of the tax deferred funds from the sale must be reinvested in the replacement property.
Those are the requirements for a fully tax deferred exchange. However, you can pocket a portion of the profit and only pay the taxes on the portion of the profit you take out while still deferring taxes on the portion you roll over into the new investment. Below is a simple graphic version of the four-part process.
1031 Exchange Time Restrictions
Most investors consider the time restrictions to be the toughest part of a 1031 exchange (especially when commercial real estate is involved). As you see in the process above, there are two strictly enforced time requirements. You must identify a replacement property within 45 days of completing the sale of the property you are exchanging for a better property.
You can identify up to three different properties as possible replacement properties. However, as soon as the replacement properties are identified, the 180-day clock starts ticking to perform your due diligence and close the deal. Missing either one of these time requirements will completely disqualify your 1031 exchange and holidays along with weekend days count.
The other major requirement is that a Qualified Intermediary must be used. This is a person holding a specific license allowing him or her to make the financial transactions on your behalf. The logic behind this is that you are never allowed to have actual or constructive receipt of the funds from the sale.
Another important point is that neither the purchaser of your old property nor the seller of the new investment property needs to directly participate in the 1031 exchange. This all might sound complicated but it’s really not once you have an expert guiding you through the process. In the end, your tax savings are enormous because you can avoid them in full.
The 1031 exchange is sometimes called a “like-kind” investment. The words “like-kind” can confuse people into thinking they have to invest in an identical property that they are selling. That is not true. You don’t have to sell a $130,000 single-family home and move up to a $170,000 single-family home. The “like-kind” requirement only means that you have to reinvest in income-producing real estate. Your upgrade could be from a single-family house to an apartment building or a strip mall. Real estate offers limitless options. The main point of a 1031 exchange is deferring the capital gain and depreciation recapture taxes so that you have more cash available for your next investment.
This is one more way you TAKE ACTION towards growing your wealth legacy!
By Wendy Patton
For more than 30 years, I’ve used the Sandwich Lease Option System to earn myself and my students millions of dollars. From my experience, I know there is plenty of room and opportunity in the real estate investment market for everyone wanting to participate to find profitable deals. It’s because of that fact and my personal success that I share the Sandwich Lease Option System with others.
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