1031-Real estate can offer tax opportunities
Welcome to our second post in an ongoing series about real estate as an investment. Today, we will be focusing on one unique opportunity that real estate can provide when it comes to taxation. And yes, I just said taxation, everyone's favorite word.
But jokes aside, ordinarily, when you sell an investment, you will owe taxes to Uncle Sam. While some exceptions exist, such as asset sales of monies held in retirement accounts, you can generally presume that you will be paying taxes on any profit.
However, when you sell investment real estate, there is an option to reinvest your sale proceeds into another property and defer taxes.
Enter the 1031 Exchange
With time, most real estate parcels appreciate due to their inherent scarcity. When this happens, the land owners experience a gain when they choose to sell the property.
At the time of the sale, the seller can enter into a 1031 Exchange, using their proceeds to buy a new investment property. When done, the IRS allows the investor to defer paying taxes on all gains into the future.
How long into the future, you ask? Indefinitely or until the property owner is deceased. Which, if the owner's estate is under the estate tax threshold, it means zero taxes for their heirs.
Multiple 1031 Exchanges
Intriguingly, during an owner's lifetime, they can process multiple 1031 Exchanges to upgrade their investment property over time. Such tax deferrals mean the ability to put one's capital to work harder (since they have more money to work with).
Furthermore, when an investor is ready to relinquish control of their properties, many solutions exist to 1031 Exchange into real estate investments managed by third parties, allowing the investor to draw income in retirement. Such a solution is one we can help you with here at Lundeen Abrams Advisors through our relationship with Ares Management, a 1031 Exchange partner that we utilize.
How 1031 Exchanges Work
1031 Exchanges are complicated (they are a tax deferral program, after all) and require due diligence. Generally, if you plan to do a 1031 Exchange, it is best to lay the groundwork for such an exchange before selling your investment property.
The first step of the 1031 Exchange is to identify a like-kind property you intend to purchase within 45 days of the sale.
Second, you MUST bring in a qualified intermediary who holds your sale proceeds and transfer them to the owner of the property selected. Importantly, you MAY NOT take possession of the sale proceeds directly, or you WILL owe taxes.
Then, once the transaction finishes, you must report it to the IRS, carefully notating everything as required.
Notably, the entire sale and purchase process must happen within 180 days or less, or the transaction loses its status as a 1031 exchange. If this happens, you will owe taxes on all gains, and all of your hard work was for nothing.
Hence, working with a qualified intermediary with vast experience and having a plan in place before your sale is essential.
Does Your Property Qualify
At Lundeen Abrams Advisors, we are here to help, and our goal is to help you create the best plan for your wealth.
If you own an investment/business property and are considering selling it, please contact us to set up an appointment to discuss 1031 Exchange options. We look forward to talking with you soon!