A Rental Property Sale and Defer Capital Gains

A Rental Property Sale and Defer Capital Gains

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A Rental Property Sale and Defer Capital Gains

If you sell your rental property, which is a “capital asset,” and book a profit, the profit is called a “capital gain.” Zacks wrote recently, “One problem with doing well with an investment is that the Internal Revenue Service is usually waiting with its hand out at the end of the transaction, expecting its share in taxes.” Typically, you’ll have to pay capital gains tax on this profit, but there are some tactics that allow a rental property sale and defer capital gains.

Rental Property Sale and Defer Capital Gains

  1. Match losses. Investors can realize losses to offset and cancel their gains for a particular year. Savvy investors harvest capital losses as they occur and then use them on current and future taxes. For example, suppose you have a realized loss of $ 50,000 on a land deal. If you sell a rental property for a gain of $50,000, the two offset and you pay no capital gains taxes. Up to $3,000 of excess losses not used to cancel gains can offset ordinary income. The remainder of the loss can be stored and carried forward indefinitely. Always seek tax and financial advice before making such moves.
  2. 1031 exchange. If you have a rental property sale, you can defer capital gains and depreciation recapture taxes by rolling the proceeds of your sale into a similar type of investment within 180 days. This like-kind exchange is called a 1031 exchange after the relevant section of the tax code.

Using a 1031 Exchange

Erin Spradlin at BiggerPockets.com shares eight rules for using the 1031 Exchanges.
  1. The rule works for like-kind properties.  The properties in question must be used for business or as an investment. This means the rule excludes primary residences, which are for personal use the majority of the time. Like-kind property also must be within the United States to qualify. For example, a seller cannot use the proceeds from selling a hotel in the U.S. to buy a hotel in London and expect to defer capital gains on the sale. Securities, stocks, partnership interests, and other financial assets are excluded from the definition of like-kind property.
  2. From the day you sell your initial rental property, you have 45 days to find a property you wish to purchase.
  3. From the day you sell your initial rental property, you have 180 days to close on a new property.
  4. You must purchase a property of equal or greater value than the adjusted value (not the price value — but the adjusted cost basis when taking into account depreciation less commissions and closing costs) of the property you sold, or you will be taxed on the difference.
  5. Warning: If you do not close on a property within 180 days of selling your initial property, you pay the capital gains tax on your initial property.
  6. During the interim of selling your first place and closing on your second, you cannot touch/look at/get close to the profits from the first place you sold. That money stays with a 1031 exchange facilitator (qualified intermediary) and not, not, not with you.
  7. The old property and the new property must be sold and bought by the same entity. Meaning, if you sell a property as John Smith, you have to buy the new one as John Smith — and not as Smith, LLC.
  8. Experts can debate this point, but a good rule of thumb for the majority of you is this: You must own your property for one year and one day to make this 1031 exchange. Otherwise, The IRS will penalize you.
  9. There is no limit how many times you can roll a transaction forward, avoiding paying capital gains taxes. Eventually, the end will come, and you will pay your taxes.

These are the basics of a 1031 exchange. If you have more questions, reach out to a 1031 facilitator, a trusted tax professional, or someone you know and respect in real estate.

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Mike Bird

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