1031 Exchange and Rental Properties

Among the many advantages of rental properties are favorable tax benefits. With a 1031 exchange, you can sell your rental homes and defer the taxes. However, failure to adhere to the numerous rules and regulations of the 1031 exchange, you may receive a huge tax bill.  A 1031 exchange is a transaction in real estate involving two similar properties; one being bought, and another being sold within a specific time frame. Restrictions surrounding the 1031 exchange are so many and the IRS does not state them clearly.

Some of the basic principles assert that the property should be used for business, be held for not less than a year, and that the new property should be found in 45 days and purchased in 180 days. If you meet all these requirements (and others), you can sell your rental property and not pay the recaptured depreciation or taxes on the profit.

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If you sell a rental house, you are required to pay taxes on the profit and also pay recaptured depreciation. The IRS allows you to depreciate a rental house because, according to them, the structure’s lifespan is limited, and its value decreases yearly. The depreciation amount can be deducted from your taxes yearly. Nevertheless, if you sell the property for an amount that is higher than the depreciated value, you will be required to pay back all the taxes you saved. Many types of real estate properties qualify for the 1031 exchange according to the IRS.

This includes any business property such as an office building, a manufacturing facility, or a store. You can also use some investment buildings such as rental properties for a 1031 exchange. The IRS states that you cannot use a fix and flip for a 1031 exchange. However, if you do not fix and flip constantly, you can use a 1031 exchange but only if you meet these set guidelines:

  • You have to rent out the property for not less than one year after you fix it
  • If it has been rented for less than one year, you can neither list nor sell it

You must use a qualified intermediary to oversee the transaction. Anyone associated or related to the TP (Tax Deferred Exchange) cannot be an intermediary. The intermediary is responsible for holding the money after the first property is sold and using it to purchase the new property.

If you do not want to pay taxes in a 1031 exchange, all the money you receive after selling the first property has to be used in purchasing the new property; otherwise, you may be required to pay taxes on the remainder amount.  In the title of the new house, you have to use the same name that was in the old property’s title. Instead of selling your original property then buying the replacement, it is possible to purchase the latter first, then sell the former. 

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