Save Capital Gains Tax on Investment Property
What is the Benefit?
A Like-Kind exchange can help you dispose of highly appreciated property and defer or eliminate capital gains. The exchange can help you switch from lower income properties to those offering a higher return. A Like-Kind exchange can help you switch from raw/agricultural land to a commercial rental property.
What is a like Kind Exchange
Internal Revenue Code §1031 provides for the deferred taxation of exchanges of certain investment properties. There are strict rules that must be followed in order for the exchange to work. In addition to both the old and new properties qualifying as "1031" property, the properties must be exchanged through a "Qualified Intermediary" within 180 days of the sale.
What a Like kind of Exchange is Not
This is not a vehicle for selling one vacation home and buying another. This is not a vehicle for exchanging one business for another (although the real estate involved with the business, as well as some other assets may qualify.) This is not a vehicle for immediately transferring ownership to your children (although this process can be an important estate planning tool!)
Steps to a Like-Kind Exchange
1. Selling property must be qualified 1031 property
2. The Agreement of sale should be designed for a Like-Kind Exchange by your tax lawyer.
3. The seller has 45 days from the date of settlement to specify a list of 1031 qualified exchange properties.
4. The Seller has 180 days from settlement to close on like-kind property from the list.
5. The money from the first settlement must be held by a Qualified Intermediary.
6. The seller of the first property must take title to the exchanged property.
7. Debt in the property may be subject to taxation.
Tax Free Wealth Building
By deferring taxation, even at the more favorable capital gains rates, permits a taxpayer to grow wealth faster. If a property were sold worth $100x, $20x would be capital gain, and there would be State taxes. The net amount to invest is $80x. If the entire property were exchanged in a 1031 transaction, there would be no reduction in investment and the entire $100x would be available for growth. If the properties are leveraged by a mortgage loan, then the growth for the exchanged property is far more advantageous.
Before you sign a listing agreement or Agreement to Sell investment property, have the agreement modified by a tax attorney for a potential like-kind exchange.