The National Association of Realtors recently reported that tens of billions of dollars in real estate transactions each year involve a tax deferral under a 1031 Like-Kind Exchange, and that congress is considering several draft proposals curbing this tax provision. That sounds like a massive sum, and it is, when taking into account large commercial sales and acquisitions of strip malls with Sam’s Clubs, sizeable office buildings, and giant land deals, but what about smaller-scale commercial or residential real estate deals?
First of all, what is Internal Revenue Code Section 1031? A tax code provision since 1924, it allows a person to exchange one investment property for another and defer the tax hit.
“Like-Kind Exchanges definitely benefit average real estate investors, especially if they want to build their equity in their financial portfolios, or spread their money into different assets,” said Sara Wiskerchen, National Association of Realtors’ spokesperson.
“For example, if you have a property in Detroit and decide to move to Las Vegas and buy there, you can use a Like-Kind Exchange. If you sell rental property, a vacation home, or real estate owned by a small business, you can buy similar property with a Like-Kind Exchange. You can also designate multiple replacement properties.” There are some requirements to meet if you exchange a vacation home, though. It has to be an investment property that is rented out.
The selling and buying must be an integrated transaction rather than two individual transactions, too. To defer capital gains when you sell your rental property, for example, you have up to 45 days to find a similar property, and the transaction must be completed within 180 days. Note: your gain is tax deferred, not tax-free.
This tax savings gives you equity to diversify your portfolio, or you could buy more investment properties or make improvements to your new property, which is why cutting this provision would hurt the community, even with small-scale transactions. When investors buy more properties or renovate their new property, new jobs in construction or property management are created.
“If you were going to go into this transaction, a Realtor should be able to walk you through it,” Wiskerchen adds.
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