Protect Your Assets through a 1031 Exchange
Posted on January 27, 2008 by Nancy Liu | Category: Real Estate
When you sell your investment or rental properties to recoup the profits you retained through the years, do not forget to pay taxes on the capital gains. How can you minimize your tax liability? A program called 1031 Exchange will help you delay the tax payment.
The 1031 Exchange was created in 1921 as part of an economic stimulus package enacted by Congress. It allows investors to sell investment properties that are used for business purposes or to generate rental income, and reinvest the proceeds in similar properties while deferring capital gain taxes. Nowadays, people have realized that exchanging is also a powerful tool to accomplish a variety of investment goals, such as estate planning, beyond delaying the tax bill.
Here is how the exchange works. After you sell your property, you have 45 days to identify a similar property in which to reinvest the proceeds. Then, you must close on that purchase within 180 days of the initial sale or by the next tax-reporting deadline, whichever comes first. In essence, the tax is deferred or carried forward into the new property. You will pay the capital gains tax upon the sale of the exchanged property.
When an exchange is executed successfully, a number of advantages can be achieved:
1. Investment property can be sold today with the resulting taxes deferred into the future. This tax-deferring strategy can be used without limit to the number of exchanges. The tax is not due until the last replacement property is sold.
2. The number and types of property that an investor owns can be consolidated or diversified. Investors may exchange multiple properties for one or two larger pieces of real estate. Conversely, investors may exchange one piece of property for varieties of property types or locations to reduce investment risk.
3. Properties can be transferred from one location to another without penalty.
Should an investor move to another part of the country, he or she may want to exchange the current investment properties into ones close to the new home.
4. Current and long-term returns on investment can be improved without tax liability.
Investors may want to alter their investment strategy by adjusting the ratio of properties that generate current income to ones with long-term appreciation potential.
5. One hundred percent of equity compounds exclusively for the investor. The deferred taxes can be reinvested, and the compounding effect is well worth the effort.
This article is only for your reference. Please do not apply mechanically to any exact cases. You are welcome to consult our attorneys at Liu & Associates, P.C. For contact information, please click here.