US Home Sale Tax Savings: Part Three 1031 Exchange

US Home Sale Tax Savings: Part Three - 1031 Exchange

Part Three: 1031 Home Replacement (Applicable to Investment Properties)

The first two steps only applied to self-used real estate. This 1031 exchange method applies to investment properties.

For two consecutive years, the property has been rented out at market price for at least 14 days each year, with personal usage time not exceeding 14 days or 10% of the rental days (whichever is higher), and there are rental agreements and income records, then it qualifies as an investment property.

Owning one such investment property allows you to upgrade from a small, old house to a large mansion or several large mansions.

However, this operation has 4 Restrictions!

Restriction 1 - Time Limit:

You need to decide which houses you want to buy within 45 days of selling your old house, and complete the purchase of the new houses within 180 days.

Restriction 2 - Amount Requirement:

The price of the new house cannot be lower than the price of the old house you want to sell, and all the proceeds from the sale must be used for the new house.

Restriction 3 - Property Type:

The new house can only be used for investment or commercial purposes and cannot be immediately occupied.

Restriction 4 - Ownership Restriction:

Once you have used the 1031 exchange method to acquire a new house, you need to wait five years before you can exchange again.

Example:

Suppose you bought a rental property for $100,000 in 2015, which is now worth $800,000. You want to use the 1031 exchange method to buy a house in a better location. You can tell your real estate agent that you want to do a 1031 exchange. The real estate agent will find a Qualified Intermediary (QI) in cooperation with their company to help you complete the process. This process is mandatory! QI (Quality Insurance) is involved because the $800,000 cheque after you sell your house won't go into your personal account; instead, it will go directly to QI and be held in a separate managed account. After selling your house, you have 45 days to choose a house you like.

To prevent losses from unsuccessful bids, you can choose up to three alternatives, and you must complete the purchase within 180 days of the closing date of your old house. If you successfully bid on a $1.2 million house, QI will directly transfer $800,000 to the seller. Then you can transfer another $400,000. It doesn't have to be cash; a loan can be used, just like a normal home purchase. The only difference is the addition of QI and the time limit.

When filing your taxes, tell your accountant that you did a 1031 property exchange and file Form 8824 with the IRS. The $700,000 profit from the old house is completely tax-free!

Isn't that amazing? The whole process is very simple; the real estate agent helping you buy a house will handle everything, so finding an agent with 1031 experience is crucial.

QI fees typically range from $700 to $1500. However, in expensive places like California, it's often over $1200. Most people, once they've experienced the benefits of 1031 exchanges, will continue to exchange to maintain their tax-free status.

But you're bound to worry that those tax-exempt amounts might one day be demanded back and you'll have to pay them.

Please stay tuned! Part Four comes in!