Most real estate investors will find themselves paying between 15% and 20% in capital gains if they sell a property and don't reinvest.
Many savvy real estate investors have caught on to the 1031 exchanges as an avenue to avoid those costly capital gains taxes.
If you're interested in growing your real estate holdings and taking advantage of the booming rental market in Boise, you need to know more about 1031 exchanges.
Read on to learn more about 1031 exchanges, how they work, and the rules you must follow.
What Is a 1031 Exchange?
A 1031 exchange, often called a like-kind sale, is part of Section 1031 of the IRS tax law.
It allows a real estate investor to avoid paying capital gains on a sold property if there was a profit from the sale. It should be noted that one of the rules is that this property can't be your personal residence.
When a property gets sold, the profits get reinvested into a new property to avoid paying the capital gains on the profits.
It should be noted that there is a laundry list of rules connected to 1031 exchanges. You can't make any mistakes, or the IRS will not approve it, and you will be paying those capital gains taxes.
How to Do a 1031 Exchange
A 1031 exchange has some precise requirements that must be met to qualify.
When a property gets sold, the profits cannot go to the seller. The profits need to get held by a qualified intermediary, sometimes called a 1031 exchange accommodation. This person must be someone completely independent of you and the seller.
They are responsible for facilitating the next purchase with the funds. Once the initial property gets sold, the buyer has 45 days to designate the replacement property in writing to the qualified intermediary.
The IRS does allow you to designate three potential properties for purchase, assuming that you will eventually close on one of the properties.
The second important rule with a 1031 exchange involves the 180-day rule. You must close one of the previously named properties within 180 days to have it continue to qualify for the 1031 tax break.
Terms to Know With 1031 Exchanges
In a 1031 exchange, depreciation is an important factor for knowing the value of a sold property. Each year, you're allowed to recognize the normal wear and tear a rental property might experience.
When the property is sold, depreciation factors into the amount you'd pay in those capital gains taxes if you didn't do a 1031 exchange. Capital gains are the amount of profit you make once you add in capital improvements made to the property, then subtract the depreciation.
When your qualified intermediary completes the 1031 exchange, sometimes there will be proceeds left from the previous sale. This is called the boot, and the IRS will tax this amount as an adjusted capital gain.
Grow Your Real Estate Portfolio While Taking Advantage of a 1031 Exchange
1031 exchanges offer real estate investors a great opportunity to reinvest profits from a sale into a new property and save on capital gains.
As a real estate investor, you might be looking for a Boise area property manager to help you take care of your investments. We can help. Contact us to learn more about our management services in the greater Boise area.