AVOID Tax on the Sale of Rental Property

Are you an accidental landlord?  Or are you maybe new to being a landlord and to rental properties, but you're looking to find a way to improve your cash flow? I know, I know it's two very different scenarios, but either way, if you own property and you're not living in it (or even if you are…), more than likely you've seen the values, just go up significant, if not tremendously!  And the big question is how much of that gain are you going to pay to the US government? Well, guess what? There are ways to defer your taxes and sometimes even eliminate them all together. The IRS ruling is called 1031, and that's what this post is all about.

So, just like always, when you make a great decision and it makes you money, the Federal Government is so happy and proud for you. They really want a slice of the pie too! So, whether you're an Accidental Landlord, or you're new to being a Residential Real Estate investor, if you've owned your property for more than three years, more than likely your values have gone up >> significantly.

And you're starting to think about how much the government is going to want of that gain. Thankfully, the IRS provides a magic pill called 1031 Tax Deferred Exchange, and it's named after the IRS code 1031. The IRS decided to reward real estate investors by allowing them to defer the taxes that they would pay on properties as long as they use the profits to invest in new real estate investments. So wait, what's the catch? Well, there are rules and you have to adhere to the rules. There are 5 rules to doing a 1031 exchange.

1. The property must be used for Real Estate Investment. This does not apply to your primary residence. It only applies to a property that is not your primary residence. It also doesn't apply if you're flipping homes. So if you're buying homes, fixing them up and then selling them 1031 Exchange is not for you.
2. There is a strict timeline to identify a potential replacement property. You have 45 days to identify options for this property. So once you sell your current property, the clock starts ticking and you've got 45 days to identify a potential replacement property to close on.
3. The clock is continuing to tick. You now have 180 days to close on one or more of those properties that you previously identified.
4. The replacement property must be of equal or greater value than the property that you're selling. And it also must be “like kind”.  
5. A qualified intermediary must facilitate the transaction. You can't close on a property, have the money go into your bank account and then go and buy another property. You don't want to do that. A qualified intermediary has to get the funds into their account. And then the qualified intermediary will provide funds for the replacement property. So if you do this correctly, there's a snow ball effect.

This means that you can actually use the proceeds and the money that you would've paid towards taxes to buy your new investment property. And the best part is you can do it over and over and over again. So you will, in many cases, eventually have to settle up with Uncle Sam, but until then, you get the opportunity to use the money that you would be paying in taxes to buy more investment properties. And if you do this multiple times, you end up being THE WINNER because while your tax bill will be higher, you also have significantly more gain to pay those taxes with.

Now, the tricky part is if you're still holding the property and you pass away, once you pass away, all of that tax debt is forgiven. That's right!! Your beneficiary will pay $0 in taxes when they take over the property.

So, you will, in many cases, eventually have to pay back Uncle Sam.  But in the meantime, you get the opportunity to use the money that you would otherwise be paying in taxes in order to put down money on new properties and continue to build more Real Estate wealth. I know, I know it sounds too good to be true. The trick here really is that you have to follow ALL of those is 5 rules above. Probably the trickiest of those rules is the 45 day identification period in this market. Properties are moving so quickly that it's hard to identify a property in 45 days. If that's the case, you still have another opportunity. There are trusts that are held for the purpose of investing in real estate. You could always identify a Delaware Statutory Trust (DST) as one of your potential real estate investments to move onto in your 1031. A Delaware statutory trust is a nice passive way to keep your money in real estate, and allow you to utilize 1031 exchange to defer taxes.  You might not make as much money as you would if you solely own a property, it's still a great opportunity to utilize your 1031 tax deferment without having to deal with the hassles of being a landlord. Your returns may not be as high, but it's significantly better than paying a massive tax bill!!

If you'd like to talk about either your primary residents or your investment residents, please do give me a call, text, email, or just click on the link down below to ha set up a free 15 minute consultation. I'd love to help you out.

**disclaimer – I am not an accountant nor an attorney, please speak to your account and attorney for advice specific to your situation**