It seems everything is going up and up these days. Capital gains, or the tax owed on selling income-producing property, has increased this year to 20 percent.
An additional tax of 3.8 percent is also hitting investors through the Patient Protection and Affordable Care Act, commonly referred to as ObamaCare.
The combination of these two taxes is hitting investors in the pocketbook at almost 24 percent.
But don’t despair; the Internal Revenue Service has created a way around paying it.
It’s called a 1031 exchange, like-kind exchange or Starker exchange.
The 1031 comes from the section of the IRS code that allows you to defer capital gains.
In 1970, a family named Starker challenged the IRS’s ruling on capital gains and eventually won the court case against the IRS.
A 1031 exchange merely allows you to swap properties without actually swapping the property.
When you sell an investment property, IRS rules will allow you to purchase a “like” property, of equal or greater value and defer the capital gains into the new property.
A third party company, known as an exchange intermediary, that’s approved by the IRS, will hold your funds from the sale of the first property until you are able to close on the second property.
If done properly, this “exchange” will allow you to defer the capital gains until the sale, or another exchange, of this second property.
It is possible, upon your death, to bequeath the property and your heirs will not have to pay capital gains either.
Through the use of the 1031 exchange, it is possible never to pay capital gains in your lifetime.
There are some important criteria that you will need to meet to qualify for the exchange:
1) The property you sell should have specific language mentioning the 1031 exchange.
2) You, as the seller, can’t accept the money at the closing. It must be delivered to the “exchange intermediary”.
3) You have 45 days after selling the property to identify the other property(s) that you will be purchasing.
4) You have 180 days after selling the property to close on the new property(s).
You’ve worked hard to produce passive income. Don’t let the tax man take too much of your hard-earned money. By using the tax code to your advantage, you can help preserve your real estate investment for yourself and your heirs for many years to come.
This story appeared in the July 3 edition of the Forsyth Herald.