One of the biggest questions on the minds of most real estate investors is: when is the right time to sell an investment property, and what is the best exit strategy?
There are so many things to consider with this question, including all of the potential tax issues that come into play.
Using a 1031 Exchange to Defer Taxes
When you sell a property, you need to consider the selling cost as well as the tax implications that come with your sale. For example, you will likely have to pay a capital gains tax on your profit. The 1031 Exchange program can be an ideal answer to that problem. With the exchange, you will use the proceeds of your sale to buy another property. Then, you can defer any tax that’s due until you sell the new property for which you have exchanged your current property.
Using a 1031 Exchange to Buy a Better Property
There are other ways that an exchange can work. Take a person who owned a property for a few years and then rented it out for another couple of years. The property’s location may have been desirable at the time of purchase, but now it’s not as strong. If the property isn’t appreciating, it might be a good idea to change the equity into an asset that is appreciating at a faster rate.
Another example of where a 1031 Exchange can work is if you have an older home that has reached the age where you have a higher number of repairs happening. Those repairs are expensive, and you may want to switch your equity into a new-build home. Then, you will have little to no maintenance issues the first five years.
Key Points of the 1031 Exchange
The most recent tax bill got rid of all the 1031 Exchanges except in real estate. To take advantage of this program, you are required to exchange like for like, meaning real property for real property. You also need to pay close attention to buying and selling timeframes. The IRS will nullify any exchange and taxes will be due if you miss a deadline. You will also need an intermediary, because you cannot touch the money yourself.
1031 Exchanges can often feel like you are changing a horse mid-stream. But, it’s not as risky as it seems. In fact, you are changing for a faster and better horse. This is a tool that can serve as a great exit strategy when you’re ready to sell a property, but you’re not thrilled about the taxes you’ll need to pay. It’s also a great way out if you’re ready to sell but you don’t know what you want to do with the earnings. You can re-invest and defer taxes over and over again.
The best part is when you can leave a property for your children in an inheritance. At this point, the tax bases will step up to the current value, and that means there won’t be any tax due for them to pay.