Real estate can be a good investment in a good market. Buying property, watching it increase in value, and then “flipping” it for even bigger or better property can not only be exciting but can result in a good profit. Yet, there is one problem that may hamper your efforts — taxes on the increases in value of each property you own. Luckily, the IRS has some relief for you.
Increases are Taxable
Let us assume that you buy property that is worth $100,000. A year later (or more), the property is worth $150,000. Once the property is sold, you now have $150,000 to buy a bigger or better property. Or do you?
In fact, you do not because the increase in value of $50,000 is taxed by the IRS. Depending on various tax factors, the taxes could eat into that $50,000, basically taking the entirety of your earnings.
Section 1031
This is where Section 1031 of the tax code comes in to help. In certain cases, what is known as a 1031 exchange can help you avoid taxes, allowing you to put all of the increase in value of one property into another property.
Section 1031 requires that the property you sell and the property you buy be of “like kind.” This is an easy test to meet, but it means that all of the proceeds go into the new property. You could not, for example, put $100,000 into new property and then pocket the $50,000 in profit as cash. Nor could you swap real estate for property that is not real estate, such as an investment, a yacht, or for school tuition. You could however, sell property for vacant land. You could sell a one unit property for a multi unit property.
You cannot use a 1031 exchange for personal use, such as a family home. It may be beneficial to first transfer your property into a corporation before doing a 1031 exchange, but you should always see a real estate professional to discuss the pros and cons of doing this.
Beneficiaries Benefit
Section 1031 has a favorable provision for beneficiaries. Let us say that you have flipped properties for years, constantly increasing the value of property through using 1031 exchanges. One day you pass away and leave the property you currently own to your heirs. If your heirs sell that property and purchase a new one, the only taxes they pay are on any increase that happened since the date of death.
Deferred Transactions
To qualify for a 1031 exchange, you do not have to swap properties at the same closing. You can close (sell property), have an intermediary hold the profits, and then purchase your new property and still get the tax advantage. The cash from the sale must be held with a qualified intermediary, and the new property must be purchased within 180 days.
Get help and advice if you are looking into flipping properties or investing in real estate. Contact a real estate attorney at The Law Office of Agnes Rybar LLC to help you from the very start of the process of buying or selling a home.
Recent Comments