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Most people are aware of the fact that when you sell a long term investment such as real estate or stocks, you have to pay taxes. And these taxes don't come cheap -- currently capital gains tax is 15%, and California has its own capital gains tax of 9.3%.
To put this in perspective, if you bought a property for $500,000 and years down the line you sell the same property for $1M, on that $500k profit you have to pay $121,500...PLUS your cost recovery recapture...but did you know there's a way you can defer that and not even pay a SINGLE PENNY??
It's called a 1031 Tax Deferred exchange. A 1031 exchange is when you sell your property and buy another like-kind property within a certain time frame and follow specific rules.
Now you have to note, that this is a *tax deferred* investment strategy. What that means is that you will just keep rolling over what you owe in taxes to some future date.
If you ever decide to completely abandon investing in real estate altogether, you will have to pay it all back. The idea though is to continuously roll it over indefinitely until you pass away.
The first step that needs to be taken when doing a 1031 exchange is the process of finding a good qualified intermediary, or QI. The QI is a company that will be the "middle man" throughout the 1031 exchange process.
There are two key time frames you have to keep track of with a 1031 exchange. From the date you sell your property, you have 45 days to identify a new property or properties. The second is that you have 180 days to CLOSE on the new property you identified; again this starts from on the date you sell your property. These dates are non-negotiable.
Within this 45 day period, you can choose up to 3 different options. The first and most common option is the "3 property rule". The rule is that you can identify a total of 3 properties at any price.
A 1031 exchange works just like a regular sale, but with the qualified intermediary acting as the "go through" person. Throughout the process, you are not allowed to touch ANY funds. If you do decide to pull any funds out, it's considered "boot" and will become taxable the second it leaves the QI's control.
By FAR the most common question I get is in regards to the "like-kind" statement. If someone sells an apartment, do they have to buy another apartment, or can they buy an industrial warehouse? The answer is YES. Like kind means real estate -- period. If you sell real estate -- be it an apartment complex, an office space or a piece of raw land -- you can buy other real estate.
The second most common question I get...Can I 1031 exchange my primary residence?? Well...you don't need to! In section 1034 of the internal revenue code, you can sell your primary residence and not have to pay taxes for up to $250k if you're single or $500,000 if you're married.
When it comes to the value of the new property or properties, the basic point is this. You have to put in equal or more money, and buy an equal or larger valued property. The loan amount is completely irrelevant so long as those two amounts are satisfied.
Remember, 1031 exchanges might not be the best option for every single person, but it's usually the most preferred option for most investors. If you're looking to avoid paying capital gains tax, the 1031 exchange is by far the most common financial technique...now that's good to know.
Contact Davide Pio Today | SF Bay Area Real Estate
http://iLiveInTheBayArea.com | 510-815-2000