When leaving investment properties or real estate, find out how a 1031 Exchange can become a smart Estate Planning tool to deal with capital gains taxes.
Depending on the size of your estate, there are various smart estate planning strategies that are helpful for minimizing or reducing taxes. A 1031 exchange allows you to defer taxes or limit taxes owed at the time of a sale, making the money that would have been spent on taxes available to increase your real estate portfolio, rental income, and personal wealth.
What is a 1031 Exchange?
A 1031 exchange is a process in which you exchange one investment or business property for another, thus deferring capital gains taxes on any profits you make from selling the first investment property. Although you do not avoid capital gains tax, you can push a significant portion of capital gains taxes owed into the future. However, you must follow specific rules for a sale and purchase to qualify as a 1031 exchange.
Three Requirements
A 1031 exchange will be recognized by the Internal Revenue Service as long as the transaction meets specific criteria:
- The exchanged properties are both investment properties.
This is the main requirement for a 1031 exchange. Investment properties are regardless of whether they were the same type of property (for example, an apartment, a building, a multifamily, et cetera). However, there are special rules when it comes to vacation homes.
- Money from the sale of the first property must be held by a “qualified intermediary” until the second property is ready to be purchased.
A qualified intermediary is a third party that escrows funds until a new property is ready for purchase. You cannot receive funds at any point in the sale of the first property and subsequent purchase of an exchange property. Thus, it is crucial to use a trustworthy and reputable company.
- The exchange needs to happen within a specific timeframe.
You must designate, in writing to the intermediary, properties you’re interested in buying within 45 days of the sale of your first investment property. You then have 180 days to complete the purchase of the exchanged property.
The 1031 exchange process can be done back-to-back without limit on the number of transactions, as long as they are all done correctly. This means that many people can defer capital taxes for very long periods.
When you ultimately decide to sell your exchanged property for cash, you’ll pay taxes at the long-term capital gains rate. That can be much less than other tax rates. For example, in 2022, the tax rate is 0 percent, 15 percent, or 20 percent, depending on a person’s taxable income.
1031 Exchanges and Estate Planning
You may not realize that 1031 exchanges can be a valuable estate planning tool. For example, if you pass away without ever selling your replacement property, your heirs will inherit it at market value. Your loved ones won’t have to pay capital gains taxes on any property value appreciation.
Considering a 1031 exchange as part of your estate planning process? You must consider additional intricacies and rules. Get in touch with the Law Office of Antoinette Bone to help you design and implement the ideal estate planning strategies that can help your heirs save on taxes.
Call The Law Office of Antoinette Bone now to schedule your appointment.
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To comply with the U.S. Treasury regulations, we must inform you that (i) any U.S. federal tax advice contained in this newsletter was not intended or written to be used, and cannot be used, by any person for the purpose of avoiding U.S. federal tax penalties that may be imposed on such person and (ii) each taxpayer should seek advice from their tax advisor based on the taxpayer’s particular circumstances.
Nothing in this message is intended to provide legal advice. This message is for educational purposes only.
