Q. I have a rental property that I have owned for years. My friend has a house that she wants to sell to me but I will have to sell the rental property if I want to buy hers. I would turn my friend’s house into another rental property if I buy it. Since it is in a nicer neighborhood, and is in better condition, I think I can charge more rent and have less headaches. Is there a way that I can buy it and not have to pay so much in taxes?
A. I am not a tax preparer or an accountant so you will want to direct specific questions to your trusted advisers.
What I can do is give you some basic information on a 1031 Tax-Deferred Personal Property Exchange. A 1031 tax deferred exchange allows an investor to defer capital gains on the purchase and sale of like kind personal property property of the same nature and character (such as rental real estate). The tax-deferred exchange preserves your net proceeds – allowing you to then reinvest the money and continue to receive returns instead of losing a portion of your profits to taxes.
There are very specific time lines that you must adhere to in a 1031 Exchange. In your case you would sell your property this is considered the relinquished property. You would then identify your friend’s property as the replacement property that needs to be done within 45 days of you selling your relinquished property. You now have to close (record) on the replacement property within 180 days of selling your property.
There are certain professionals that you may want to help you through this process. First of all you need to include appropriate language in the sales contract to be sure all parties are informed of and acknowledge your intention to do an exchange. A real estate professional can help you do that. You will also need to use a facilitator to prepare the legal documents necessary to facilitate the transaction. This will include the exchange agreement, assignment, exchange contract addendum and exchange account closing summary. The facilitator is also responsible to hold the exchange proceeds so that you don’t have actual or constructive receipt of the funds which would invalidate your tax deferred status.
Many investors take advantage of deferring taxes when upgrading their rental properties. The 1031 Exchange is a great tool that can help you preserve your proceeds while improving your holdings. Best of luck in acquiring your new rental property.