You can also sell appreciated stock over time to spread the capital gains. Investment real estate does not have the same privilege. The entire gain amount must be claimed on taxes in the year that the property was sold unless certain steps were taken to minimize this risk. An investor can defer capital gains by purchasing a similar investment property if he or she uses IRS Code Section 1031 to recognize a " like-kind" property exchange.

How To Manage The Sale Date

This tax burden could be mitigated by controlling the year that title or possession is transferred from your hands, and therefore the year in determining the capital gains. You can also set the year for which you anticipate having a lower tax burden.

The Internal Revenue Service (IRS) states that net capital gains may be subject to 0% tax if your taxable income falls below $80,000. Therefore, you could avoid taxes on minimal capital gains if you have minimal passive income and no active earnings. If your income is stable and you don't expect to pay tax on the gain, then the IRC Section 103 exchange may be a good option.

Section 1031 Exchange

An investor can trade real property held for investment to obtain no tax liability. For example, if you trade business or investment properties for the sole purpose of buying or selling a business or investment asset, there is no gain or loss until the property is sold.

Rules And Regulations

Section 1031 of the IRS Code will not allow for capital gains tax to be avoided in any case. Exchanging U.S. real property for real estate in another nation will not be eligible for tax-deferred status. Trades that involve property used for personal reasons, such as exchanging a personal home for a rental property, will not be eligible for tax-deferred status. The exchanged property will be subject to tax if it is between related persons.

The basis from the old property is transferred to the new property for tax reporting purposes. It is important to know that taxes owed are not forgiven. They are just postponed until the new property is sold. 4 In order to record the Section 1031 exchange, you will need to file Form 8224 with the Internal Revenue Service. This form is required for the tax returns for the year of exchange and for each of the subsequent years.

Section 1031 And Losses

If you sell your investment property at a loss, you can also make a tax-deferred trade. First, determine whether the loss is a tax loss or a personal loss. To be considered a tax loss, the adjusted basis must exceed the selling price. The adjusted basis includes any previous deductions that you took (or were permitted but did not take).

Let's say you buy a rental property at $400,000. Your current adjusted basis is $300,000. Your current adjusted basis stands at $300,000. Therefore, your current adjusted basis is $300,000. This gain is an unrecaptured Section 1250 gain and is subject to a 25% tax. To avoid taxes on your $50,000 gain, you can purchase a property of "like-kind" to get around the tax.

Let's say you sell the home for $250,000. You will also be subject to a $50,000 tax loss. Are there any benefits to a "like-kind" trade? It is possible. It's possible.

Fully Tax-Deferred Exchange

Certain Conditions Are Required For A Section 1031 Tax-Deferred Exchange Transaction To Be Possible:

Property Must Be "Like-Kind."

Properties can only be considered like-kind if they have the same character or nature, regardless of their grade or quality.

Property Must Relate To Investment Or Business

Exchanged property must only be used for investment or productive business purposes and must not be traded. An exchanged property, for example, must not be held primarily for resale.

The New Property Must Have Been Identified Within 45 Calendar Days

The seller must identify the new property in writing within 45 days after the initial transfer.

The Transfer Must Occur Within The 180-Day Window:

Similar-kind property must arrive by one of the following two dates (whichever is earlier). Within the 180 days after the property transfer or by the tax returns due date (including extensions), for the year the property was transferred.

Partially Tax-Deferred Exchange

The exchange of property must be a single exchange of like-kind properties to be tax-deferred. A Section 1031 exchange is possible if the property has the same trade value. Unfortunately, it's not easy to find an equal exchange. In many cases, however, one party will add some cash to ensure the deal is fair. This extra property or cash is called " Boot" and is subject to tax up to the amount received.

The mortgages are netted if there are mortgages for both properties. The larger mortgage is given up by the party receiving the smaller mortgage. The excess is considered to be boot.

The Summary

Many people have been able to get favorable tax treatment by the federal government due to an increase in real estate sales. Unfortunately, a tremendous amount of tax revenue has been lost as a result. Section 1031 exchanges remain for real property. If you plan to sell a rental property, it is a good idea to consult a tax professional to determine which tax rules apply to you.