Turning Homes into Investments with Smart 1031 Tax Moves.
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A 1031 exchange is a special tax rule that helps real estate investors save money on taxes when they sell one investment property and buy another. Instead of paying taxes right away on any profit they make, they can delay those taxes by using the money to buy a new property that is similar, or “like-kind.” This rule works for all types of real estate in the United States, such as homes, apartments, office buildings, or industrial spaces. However, it does not work with properties in other countries or U.S. territories like Puerto Rico.
For example, someone who owns a rental home in California can use a 1031 exchange to buy an apartment building or warehouse in New Jersey or New Mexico without paying taxes at that time. The taxes are only due if they sell the new property and don’t do another exchange.
If someone lives in a house and wants to use a 1031 exchange later, they have to turn their home into a rental first. They need to move out and rent it for a while to show that it’s now an investment. This is a smart idea in places where home values have gone up a lot, like in California. In some cases, homeowners can avoid taxes on up to $500,000 of profit if they’ve lived in the house for two of the last five years. Then, they can use a 1031 exchange for the rest of the profit.
People who already have a rental home can also use a 1031 exchange to trade up to better properties, lower their risk, or make more money. Some investors use a “reverse exchange,” which means they buy the new property before selling the old one. This helps when the market has low inventory or it’s hard to find the right property in time.
Investors also need to remember that the 1031 exchange only gives them 180 days to finish the process. But if their tax filing deadline comes first, they must file for an extension. This gives them the full 180 days. For example, if someone sells their property in late 2024, they might need to file for an extension in 2025 to finish their exchange.
Talking to a tax expert is very important to avoid mistakes and take full advantage of this rule.
