1031 Exchange: Tax Free Real Estate Investing

The 1031 Exchange is a segment of the United States tax code which defines how a real estate investor can purchase a slice of real estate for investment purposes and resell it after a few years without having to pay taxes on the profits made off the sale. Let’s say for example, you buy a home for 80,000 rent it out, but after two years you sell it for 100,000. So you have a profit margin of $20,000. There’s quite a few taxes that you will be required to pay on that profit like a capital gains tax, local taxes, and etc. If the reason you sold your rental property was purely to invest in a new property with a 1031 Exchange you can take your profit of $20,000 and use it to invest in the new property without paying taxes on it.

This only works with Rental Properties not Flipping Properties

Rules and Tips:

Net Selling Worth

If you purchased a property for $80,000 but are now selling it for $100,000 the new property you want to apply the profit towards must be at least $100,000. It can also be a few properties that equal to the amount of $100,000 or more.

Identify the Property
You have 45 days to find the property you want to purchase and then close the deal within 180 days. If you do not close within 180 days you will receive the property profits and be required to pay taxes on it.

Period of Ownership and Intent
The period of Ownership must be two years or more in order to be in “safe harbor”
Intent to rent out properties

Identical Tax Payer
You cannot buy and sell with investment companions. If you own the original home you are selling, you must be the name on the new investment deal as well.

The Process:

Old property is put under contract with a new buyer
The Intermediary is found and approves the HUD Closing statement
Profits go into an Escrow Account
You have 45 to find the new investment property
You have 180 days to close on said property
Money is put towards the closing of the property

Helpful Note:

If you buy a property with cash and put some rehab money into it, you can create a mortgage with yourself as the borrower in order to have the HUD show a $90,000 tag.

There is also what is called a Reverse 1031 for when you find a property you want to buy before you sell the current property you own. This is much more difficult to accomplish and involves you having the upfront cash or loan to purchase a property.

Benefits of 1031:

You can take a rental property that is not doing well and sell it without having the profits taxed, in order to put those profits fully towards a new investment.
A long term wealth building tool.