Investors who are either thinking about getting rid of their worst performing property and buy another one or sell their low income producing property to buy better one should highly consider 1031 Exchange option. Just before the current property investment deal is sealed, check to see if you’ll owe taxes on the sale of your property, even if you’re taking a loss on it? That’s key to unlock big tax savings by avoiding a common misconception: no profit means no taxes as per investment specialists.
A 1031 Exchange is a tool for investors to defer capital gains taxes on the exchange of like-kind properties. This tax-savings strategy can help investors avoid a tax liability when they sell one investment property and buy another. If you realize that you could be facing a hefty tax bill on your property sale, even when selling at a loss, you could benefit from options that 1031 exchanges provide them. “Don’t lose the equity you built on your current property, use to invest in your next property”.
Here is an example, taxes were owed on a property sold at a loss. The client purchased a rental property in 2001 for $495,000. The property sold for $477,000, an $18,000 loss. Yet, the owner faced a tax of nearly $20,000 on the sale, because taxes are paid on capital gain, not the equity or profit from the sale. The owner had claimed depreciation on the property over 10 years of ownership, netting an $80,000 gain that still had to be factored in. If the owner had done a 1031 exchange, the owner’s tax bill would have been zero.
Just talk to you Realtor while selling your investment property and planning to buy another one immediately. You can also determine yourself by asking questions like,
- Do you think if there will be a tax hit from the sale of the property? Consult with your CPA or tax consultant to determine it.
- Are you sure there is no capital gain?
- What is your next plan? Invest in another property or use the funds for something else?
These questions will atleast get you started and help you to discuss more about this exchange idea with your Realtor to do tax-deferred transaction which will save your hefty tax bill. You can also check on this post at Realtor.com which talks about rules of 1031 Exchanges to get some insights.
First and foremost, don’t forget to talk to your Realtor as soon there is deal and well before closing of the current property. Secondly, don’t lose out on an opportunity to save on tax dollars. Finally, just keep in mind, 1031 Exchange is very feasible solution but it might not work all the time.