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HOW TO AVOID CAPTIAL GAINS ON INVESTMENT PROPERTY

Kunal A. Mirchandani, Esq. - Thursday, December 13, 2018

There are only two certainties in life: death and taxes. Luckily, through advancements in healthcare and the tax code, both of these can be delayed. Section 1031 of the Internal Revenue Code provides a solution for delaying capital gains on investment property, commonly known as a “1031 exchange.” There are important restrictions and requirements for a 1031 exchange, but the real estate attorneys at the Klein Law Group can advise you through every step of the process. 

FIRST – THE PROPERTY SOLD AND THE PROPERTY PURCHASED MUST HAVE A PRODUCTIVE USE

You must actively use the property for a trade or business. If the property is just being held as inventory, then the transaction will not qualify for a 1031 exchange. For example, a community developer that sells houses does not qualify. Also, in most circumstances, people who fix-up homes do not qualify for a 1031 exchange. The exception is vacant land which will always qualify for a 1031 exchange. 

SECOND – THERE MUST BE A LIKE-KIND EXCHANGE

A “like-kind” exchange means the property being sold and the property being purchased are both for an investment purpose.  It does not matter whether the property being sold is a commercial warehouse, but the property being purchased is a condominium. The “like-kind” exchange can happen between almost anything, like a shopping center, vacant land, rental home, condominium, office building, or leasehold interest for thirty years or more. Unfortunately, a primary residence can never qualify for a 1031 exchange.

THIRD – TIMING IS EVERYTHING

You must identity new investment property within forty-five days of selling the old investment property. Notice of identifying the new investment property must be given to a qualified intermediary or the IRS. A qualified intermediary is the company that will hold the sale proceeds of the old investment property while you are waiting to close on the new investment property. The Klein Law Group can act as a qualified intermediary.  You can invest in up to three new properties as long as their total value does not exceed twice the sale price of the old investment. Finally, you must purchase the new property within 180 days of selling your old investment. 

FOURTH – SIMILAR INVESTMENT

Although the new property may be completely different from your old investment, some things must be similar. Title to the new property must be exactly as it was with the old property. If you need to have title in a different name, then sometimes it can be beneficial to quit claim deed the old property just prior to sale. Another similarity is the requirement that the initial investment and any growth must be reinvested in the new property. The money taken out, often called a cash boot, does not qualify for the 1031 exchange. The amount required to payoff a mortgage used to obtain the property, commissions, and closing expenses do not need to be reinvested. Notably, if you purchased property and later took out a mortgage, paying off that mortgage does not reduce the amount required to reinvest.

FIFTH – QUIRKS AND FEATURES 

While this may seem simple in theory, the real world will always present unique problems and situations. The real estate attorneys at the Klein Law Group know how to overcome these obstacles and get results. For example, you may have already identified a lucrative new investment, but are waiting to sell the old investment property. The solution could be purchasing the new property, parking title with an intermediary, then selling the old investment within 180 days. The Klein Law Group can advise you about theses transaction, documentary stamps, entering into a qualified exchange accommodation agreement with the intermediary, and other issues.  

You may never avoid death and taxes, but there are ways to delay the inevitable. If you have questions about a 1031 exchange, then you are strongly encouraged to contact the professional and capable real estate attorneys at the Klein Law Group.