Protecting your wealth is an important part of investing in real estate. If you want to defer taxes on the sale of an income-producing property, a 1031 Exchange can be one way to do that. Today, we’re sharing three vital pieces of information: the definition of a 1031 Exchange; how to perform a 1031 Exchange; and, why this type of tax deferment can be beneficial to anyone who owns rental properties in California.
What is a 1031 Exchange?
This investment tool is named for Section 1031 of the IRS code. Property owners can defer the taxes that may be due on the sale of a property by investing those profits into the purchase of another property. If you earn a lot of money off the sale of a rental property, you’ll have to pay capital gains taxes. But, if you’re willing to use the proceeds from the sale of your property to buy another income-producing property, you won’t lose any of that profit to taxes.
How to Perform a 1031 Exchange: Rules and Timelines
You have to exchange like properties to take advantage of the 1031 Exchange. This means you can’t sell the home you’ve been living in and then avoid capital gains taxes by purchasing a vacation home. Instead, you need to buy another income-producing property with a value that matches or exceeds the property you’ve sold. So, if you sold a property and earned $600,000 in profit, you have to use that $600,000 to buy another rental property or several rental properties. You can sell one single-family home and buy three condo units. Or, you can sell a multi-family building and buy two single-family homes. The properties don’t have to be exactly alike, but they do have to be investment properties.
There are also deadlines. If you’re going to do a 1031 Exchange, you have to identify the property or properties you want to buy within 45 days of closing on the property you sold. You also have to close on the new deal within 180 days of selling the original property. The entire transaction must be completed within those 180 days, otherwise you’ll be liable for taxes. It’s also important to use an intermediary who will handle your trust account. You cannot touch any of the money that you earn from the sale of your initial property.
Benefits of the 1031 Exchange
There are several benefits for California investors who use the 1031 Exchange. It allows you to dispose of the property without paying capital gains taxes. If you’ve wanted to sell a property but you weren’t thrilled about paying the taxes, this is one way to continue growing your investment portfolio. Other benefits include:
- You can increase the number of assets in your portfolio. When you sell one property and make a lot of money, you can use the proceeds to buy two or three properties instead of just one. This provides you with additional rental income streams.
- You can save on maintenance costs. If a particular rental property has stopped cash flowing because of all the maintenance and repairs that have been necessary, you’ll be able to take it out of your portfolio and replace it with a newer property that has less expenses attached to it.
- You can stay in the California real estate market. Many investors hesitate to sell a property in California because they don’t think they’d be able to re-enter a market that’s growing less affordable. With a 1031 Exchange, you can sell that property and continue investing in real estate that will appreciate in value.
We love to help and empower investors to be more successful with their rental properties. If you have any questions about the 1031 Exchange or anything pertaining to property management in Sacramento, please contact us at Titan Property Management.