As a solo real estate investor at Jason Cohen Pittsburgh and as part of a real estate investing group, I’ve been taking advantage of the 1031 Exchange. It’s not for everyone. It’s not for the casual investor who supplements a full-time career with income from a rental property. Indeed, the beneficiaries of the 1031 Exchange are investors who intend to take the profit from one property and sink it right back into another.
Also known as a “like-kind exchange,” this tax deferral program offers a tax break to investors who use the sale of one property to generate capital used to invest in another similar property. At Jason Cohen Pittsburgh, we use this strategy because we constantly acquire multifamily investment properties in Pittsburgh. We renovate, rehabilitate, and reposition these properties for resale as high-end rentals. Then we use the money from the sale to acquire a new property to repeat the process. The benefit of the 1031 Exchange is the deferral of taxes, saving us money in the property exchange.
When performing a typical real estate transaction, the owner pays taxes on gains from the sale. Section 1031 of the Internal Revenue Code provides an exception to this rule for property sellers who take this gain and reinvest it into another like-kind property. Not only is this stipulation for like-kind property, but also includes cash and liabilities. The theory is that the profit hasn’t been realized yet because the recipient of the sale hasn’t actually acquired cash from the transaction. Instead, the seller has used the money to put directly into another similar investment.
The swapped properties must have the same use. You can’t defer taxes while selling your multifamily investment property to buy a home to live in. That’s why the 1031 Exchange is such a boon for companies like Jason Cohen Pittsburgh.
There are five types of exchanges under this program:
- Simultaneous exchange: The selling and buying takes place at the same time
- Delayed exchange: There is a time gap between the sale of the relinquished property and purchase of the replacement property. There is a limit to the amount of time between these two actions, as dictated by Treasury regulations.
- Improvement exchange: The investor can renovate or rehabilitate the replacement property using the proceeds from the sale.
- Reverse exchange: The purchase of the replacement property occurs prior to the sale of the relinquished property.
- Personal property exchange: Other personal assets are traded along with the real estate, as long as the personal property is like-kind.
In order to qualify for the tax-deferred exchange, the properties must be:
- Like-kind: The relinquished and replacement properties must be the same type, i.e., both must be real estate. A 1031 Exchange cannot be used to trade stocks for real estate, even if they are of an equal value.
- Proper use: The properties must have a similar use as an investment. Qualifying properties cannot be flipped or be the owner’s personal residence.
The properties must be exchanged for one another, not a total cash sale. Purchasers have a 45-day window in which to locate a suitable replacement property in order to have the tax deferral and the exchange must be completed within 180 days of the sale.
At Jason Cohen Pittsburgh, we specialize in acquiring multifamily properties. The 1031 Exchange is a valuable tool that allows us to defer taxes while we acquire a number of properties.
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