If you’re looking to sell an investment property, but realized the sticker shock of taxes, you’ve probably come across a confusing option called a 1031 exchange. 1031 exchanges are great for real estate investors because they can save you money, but you have to know the nuances and jargon that comes along with them. This includes capital gains taxes, the process in which they work, as well as knowing each of your options with profits and losses.
Below you’ll learn the ins and outs of selling investment properties using 1031 exchanges without all of the legal jargon. If you still have questions, contact us using the email address or phone number in the top right corner of this page, and one of our professional settlement agents will be happy to assist you.
What is a 1031 Exchange
1031 exchanges are when you take the profit from your current investment property, and apply it to your next investment property during the settlement process. It is popular for real estate investors because it allows you to use the money on your next project without having to pay capital gains taxes (taxes on the profit), giving you more money to use and grow your business. However, there are restrictions.
The new project must be an investment property, and cannot be used for a personal residence. You also have to identify and claim the property within 45 days of settlement, and close the deal within 180 days. You must also use all of the profits from the sale towards the new home if you want to have 100% of the taxes deferred. Any profits you do not invest immediately will cause you to owe taxes on the revenue, and it pretty much defeats the purpose of selling investment properties with a 1031 exchange.
How to Calculate Tax Savings Using a 1031 Exchange
Understanding how capital gains tax works is helpful when you emphasize the “gain” in capital gains. It’s as easy as subtracting the price you originally paid for the property from the price you are selling it for.
If you are selling the investment property for $120,000, but you paid $100,000, your capital gains is $20,000.
$120,000 – $100,000 = $20,000
The $20,000 is what you now owe taxes on. This is also known as your capital gains.
If you have your next property lined up, or find it within 45 days of selling the property, you can take this $20,000 and put it towards this new project tax free. That is the benefit of a 1031 exchange. But what if you also want to take some money for yourself. You can do this too.
If you need cash to pay bills, go on vacation, or simply want to reap the rewards of your work, you can opt to apply part of it towards your next project and take the rest for personal use. But you will owe taxes on the portion you keep.
Using the example above, let’s say you want $10,000 to keep. Instead of taking the $20,000, you apply $10,000 to your next project tax free by using the 1031 exchange, and keep $10,000 for yourself. The $10,000 you put towards the next project (as long as it is within the 45 and 180 day windows mentioned above) is cleared. You now only owe taxes on the $10,000 you’re taking for personal use.
That is the beauty of selling investment properties with 1031 exchanges. You control your own money, and you get to decide what happens with it. You can reinvest it back into your business tax free, or keep a portion while reinvesting the rest. If you have any questions about selling investment properties using a 1031 exchange email us at info@atgtitle.com and one of our settlement agents will be ready to help.
