The real estate market is hot right now, and if you’ve thought about selling an investment, you’re certainly not alone. However, smart investors are careful about what they do with their rentals. Selling can earn you some great income right now, but selling a Chapel Hill rental property also comes with paying taxes.
Taxes are part of what you expect as a real estate investor. But if you could delay or defer the payment of those taxes, would you?
Well, you can.
The IRS allows for a 1031 exchange, which is a program that encourages investors to defer those capital gains taxes by re-investing the earnings from a sale into another purchase.
There’s a lot you need to know to conduct a 1031 exchange effectively, however. While a 1031 exchange allows you to keep more of the money you’ve earned and establish a more effective long-term investment strategy, you have to follow its specific rules and timelines.
Benefits of a 1031 Exchange for Chapel Hill Rental Homes
With home values as high as they are now, you’re likely to earn a healthy profit on the property you sell. To avoid tax liability, use that money to buy another rental home or several rental properties that are similar to the one you’re selling. Similar does not mean exactly the same. You can sell one single-family home and buy two condos. Or, you can sell one apartment building and buy two single-family homes. There are plenty of options.
You will certainly benefit from the 1031 exchange if your rental property is older and maintenance costs have been steadily increasing. Selling a home with ongoing repairs will allow you to reinvest the proceeds into a newer property that will provide better cash flow.
How to Manage the 1031 Exchange Process
Specific steps need to be taken when you want to defer your taxes with a 1031 exchange.
- Make sure your property qualifies for this benefit. This tax program is meant for investment homes. You cannot sell the home you’ve been living in and reinvest the money to buy a vacation home.
- You’ll need to exchange with a like property or properties. The new property you choose must have a value that is the same or higher than the original property. If you walk away from the exchange with any profit, they will be taxable.
- Find one property, two properties, or three to exchange with your current property.
- Use an intermediary and don’t take any of the cash from the sale of your property. The intermediary will hold your funds until they can be reinvested in your new purchase. Ask your property managers for a referral.
Timelines for the 1031 Exchange
Time is always of the essence when it comes to real estate, but it’s especially true when you’re managing a 1031 exchange. Here are the timelines:
- You’ll need to identify a replacement property within 45 days of selling your original property (this doesn’t mean you have to buy it – you simply must identify it).
- You have 180 days to close on the new sale.
The entire exchange must take place within the 180 days (meaning you don’t have 45 days plus 180 days – the clock does not reset).
Remember this isn’t a completely tax-free option. You are technically deferring the payment of your taxes. However, there are no limits to how many times you can execute a 1031 exchange. If you want to leave your investment property to your children or beneficiaries after you die, they’ll receive a step-up, which will let them avoid all the taxes you deferred.
If you’re interested in a 1031 exchange and you’re wondering where to get started, contact us at Real Estate Experts. We specialize in Chapel Hill property management and we also serve communities in Durham, Mebane, Hillsborough, North Chatham County, and Terri.