Is A 1031 Exchange Right For Me?
I purchased an undeveloped lot in NW Florida Sept. 2004 as investment property. It has now doubled in value, and I am considering selling and reinvesting the profit in another larger investment property. I am completely new to real estate investment, and am trying to determine if a 1031 exchange is right / possible for me. Several questions:
1. I understand the time-limits for new property for the exchange (45 days to ID new investment, 180 days to close on it). Is there a mandatory time period for holding property before one can do a 1031 exchange? (if it is one year, I haven't owned my property for long enough).
2. I am considering reinvesting in a new-build home that is pre-construction (in a new development neighborhood) in the same area. Is it possible to "trade up" to this, and if so, must I wait until the home is finished before closing? If so, that would probably make the 180 day window difficult to achieve.
3. If I understand the 1031 Exchange process correctly, I could continue to do exchanges in like-kind property indefinitely, thereby avoiding the capital gains tax, as long as all of the profit goes into the next property and all rules are stringently followed. Is there a downside to this? I have a unique situation, in that I am currently a foreign aid worker overseas (with family in NW Florida), and my current income qualifies for the foreign earned income exclusion from Fed. income tax (since I pay no federal income tax on my earned income, I believe that I do have a buffer for some tax on short-held investment property if I sold after less than a year). If I understand the 1031 cycle properly though, I could sell this property with no taxes, then reinvest in like-kind property, trading up through the next 20 years, then live in the final property for 5 years, and finally sell with no taxes. Am I missing something here?
Thank you in advance to those of you with experience who can advise.
1. The is no statutory or regulatory stated time period, but there are concerns regarding the holding period. There is an article on this web site under tax strategies regarding holding periods for 1031 exchange properties. Just search under holding period.
2. You must close escrow on the completed home no later than the 180 calendar day period in order to qualify as "like-kind" property receive as part of your 1031 exchange.
3. You can certainly continue deferring your capital gain taxes by continuing to do 1031 exchanges. I am not an expert in foreign aid worker and related tax issues, so I would consult with a competent tax advisor that has experience in this area. One correction. Once you ultimately move into the property and convert it to your primary residence, you would exclude up to $250K in capital gains if you are single and up to $500K if you are married. Any capital gain taxes above that would be taxable under current law. Alot can change in 20 years.
Number 2 is correct. Each time you complete a 1031 exchange transaction your cost basis is deferred into the new replacement property, your depreciation taken (future recapture) is deferred into the new property and the capital gain is deferred into the new replacement property. So, all of your capital gains are deferred over time and therefore have "built up" and would all be recognized when you ultimately sell. However, with property tax planning and property estate planning, you can completely eliminate most - if not all - of your capital gain and estate taxes.
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