1031 Exchange Alternative | Capital Gains Tax On Real Estate (2024)

FAQs

Is it better to pay capital gains tax or do a 1031 exchange? ›

A 1031 Exchange allows you to delay paying your taxes. It doesn't eliminate your capital gains tax. Only if you never sell your 1031 exchanged property or keep on doing a 1031 exchange, will you never incur a tax liability.

Use a 1031 exchange for real estate

Internal Revenue Code section 1031 provides a way to defer the capital gains tax on the profit you make on the sale of a rental property by rolling the proceeds of the sale into a new property.

One of the downsides of 1031 exchanges is that the tax deferral will eventually end and you'll be hit with a big bill. However, there is a way around this.

Utilizing a Deferred Sales Trust, investors can defer capital gains taxes over time. Deferred Sales Trusts provide an alternative to 1031 exchanges for deferring capital gains taxes on appreciated assets.

Section 1031(f) provides that if a Taxpayer exchanges with a related party then the party who acquired the property in the exchange must hold it for 2 years or the exchange will be disallowed.

If you try to exchange very quickly after acquiring a property or go through many properties a year, the government may consider you a dealer and the properties would then be considered stock in-trade, and therefore, would not be eligible for the 1031 exchange rule.

Billionaires (usually) don't sell valuable stock. So how do they afford the daily expenses of life, whether it's a new pleasure boat or a social media company? They borrow against their stock. This revolving door of credit allows them to buy what they want without incurring a capital gains tax.

Whether you're 65 or 95, seniors must pay capital gains tax where it's due. This can be on the sale of real estate or other investments that have increased in value over their original purchase price, which is known as the “tax basis.”

You can avoid capital gains tax when you sell your primary residence by buying another house and using the 121 home sale exclusion. In addition, the 1031 like-kind exchange allows investors to defer taxes when they reinvest the proceeds from the sale of an investment property into another investment property.

The Deferred Sales Trust is an effective 1031 exchange alternative to help business and real estate owners sell their assets and defer capital gains tax. Both the 1031 exchange and Deferred Sales Trust are well-established investment strategies.

Can you lose money in a 1031 exchange? ›

Structuring A 1031 Exchange Will Defer A Gain Or Loss

You can not change your mind when you complete your income tax return and realize that you actually have a loss. The loss must be deferred if the disposition or sale was structured as a 1031 exchange transaction.

There are three principal reasons why Section 1031 Exchanges fail: A failure on the Exchangor's part to identify property choices by the 45th day. The choice of Replacement Property becomes unavailable, with no backup identified.

A few options to legally avoid paying capital gains tax on investment property include buying your property with a retirement account, converting the property from an investment property to a primary residence, utilizing tax harvesting, and using Section 1031 of the IRS code for deferring taxes.

Reinvest in new property

The like-kind (aka "1031") exchange is a popular way to bypass capital gains taxes on investment property sales. With this transaction, you sell an investment property and buy another one of similar value. By doing so, you can defer owing capital gains taxes on the first property.

Here's how it works: Taxpayers can claim a full capital gains tax exemption for their principal place of residence (PPOR). They also can claim this exemption for up to six years if they move out of their PPOR and then rent it out. There are some qualifying conditions for leaving your principal place of residence.

The most important thing to understand is that long-term realized capital gains are subject to a substantially lower tax rate than ordinary income. This means that investors have a big incentive to hold appreciated assets for at least a year and a day, qualifying them as long-term and for the preferential rate.

You can avoid capital gains tax when you sell your primary residence by buying another house and using the 121 home sale exclusion. In addition, the 1031 like-kind exchange allows investors to defer taxes when they reinvest the proceeds from the sale of an investment property into another investment property.