1031 Exchange 5 Year Rule

Buying_REpageWhy not build up to your dream home by utilizing a 1031 exchange to your benefit? By taking advantage of a 1031 exchange you can defer your taxes by reinvesting all of your gain into a like-kind property. A recent revision in the tax code is allowing investors the chance to defer even more of their taxes. Section 121 was amended on October 24, 2004 and affects those who have completed a 1031 exchange or are considering one. The revision allows investors to convert an investment property into a primary residence, as long as they own it a minimum of five years (for all property bought after October 24, 2004). At this point, the principal residence exclusion rule will apply, and the investor can exclude capital gains of up to $250,000 if single, and $500,000 if married. It is that easy, if you hold the property 5 years after then exchange, you can total wipe out the gain, if the house was your primary residence for 2 of the last 5 years.

The Conference Agreement on H.R. 4520 includes the following provision to amend §121(d): “Recognition of gain from the sale of a principal residence acquired in a like-kind exchange within 5 years of sale.If a taxpayer acquired property in an exchange to which section 1031 applied, this subsection shall not apply to the sale or exchange of such property if it occurs during the 5- year period beginning with the date of the acquisition of such property.”

The rules for a 1031 exchange are simple:
• Only investment real estate qualifies for a 1031 exchange.
• Replacement property must be identified within 45 days of the closing of the relinquished property
• You can’t touch the sale proceeds; they must be held in escrow by a qualified intermediary.
• You must close on your replacement property within 180 days of the closing on your relinquished property.

Following the rules for a 1031 exchange will guarantee that you are able to defer the taxes on your sale and reinvest all of your proceeds into a new investment property. But wait, it gets better. If you buy a rental property, you can deduct all the expenses related to running that property. These expenses include taxes, interest, maintenance, repairs, and any other expense incurred while owning that property. On top of that, you have a monthly cash flow and you get to depreciate the cost of the property (which is allowed as a deduction spread over 27.5 years). By making a wise investment decision and knowing about the benefits of a 1031 exchange, you can defer your taxes and benefit from appreciation.

By Dave Owens, CPA, CES