Normally, selling an investment property for more than its purchase price means paying significant capital gains tax. However, a 1031 exchange allows you to defer these taxes by reinvesting the proceeds into a new property, essentially making an “exchange” rather than a sale. This process comes with strict regulations, so it’s important to follow the 1031 exchange rules meticulously.
Eligibility for a 1031 Exchange
To qualify for a 1031 exchange, you must meet these basic criteria:
- Investment Properties Only: This rule applies strictly to investment properties. The properties involved must be used for investment purposes, such as rentals or properties intended for flipping. Personal residences do not qualify.
- Equal or Greater Value: The replacement property must be of equal or greater value than the one being sold. This means you’re essentially “trading up” in property value.
Key Rules to Follow
• Escrow Account: The proceeds from the sale of your original property will be held in an escrow account managed by a third party. You won’t have access to these funds until you close on the new property.
• 45-Day Identification Period: Post-sale, you have 45 days to identify potential replacement properties.
• 180-Day Purchase Period: After identifying the properties, you have 180 days to complete the purchase.
Additional Guidelines
• Three-Property Rule: You can identify up to three potential replacement properties, provided you close on at least one.
• 200% Rule: You can identify any number of replacement properties as long as their combined fair market value doesn’t exceed 200% of the value of the property sold.
• 95% Rule: If you opt to ignore the 200% rule, you can identify any number of potential replacement properties, but you must acquire at least 95% of their total value.
These rules are stringent, and there are no exceptions or extensions. Mistakes could result in disqualification from the 1031 exchange benefits, leading to a substantial tax bill. Consult a professional accountant or real estate agent for guidance.
Know what is a 1031 Exchange, click here.
Ready to sell? Know your home’s worth, click here.
Homes for sale in Carmel Valley click here.
Shirin Rezania Ramos | 858.345.0685 | www.shirinramos.com | Compass, DRE 0203379
