1031 Exchange and Investment Properties

Selling an investment property? Here’s how to defer paying the capital gains tax

If you’re thinking about selling an investment or business-use property, you could be hit hard by taxes. The capital gains tax is something sellers don’t always think about until it’s too late. Luckily, there’s a way to defer the capital gains tax when it comes to investment properties.

To help explain how it works I turned to Shanae Mabrie of Old Republic Exchange Company. She’s been in the real estate industry for about 15 years and is an expert in facilitating 1031 Exchanges. Basically, a 1031 Exchange gives you a tax advantage because when you sell an investment property it allows you to defer paying the capital gains taxes.

Shanae gave me a quick explanation of how a 1031 Exchange works. When you sell your existing investment property you then reinvest the proceeds from that sale into another property or properties. A qualified expert, like Shanae, holds the funds in trust for you until you’re ready to reinvest. Keep in mind, though, the clock is ticking.

You have just 45 days from the date of closing on your original property to identify which property or properties you’re planning to buy. You have just 180 days from closing on the sale to complete the purchase of the new property you previously identified in writing. That’s not a lot of time so you need to act fast. If you’re planning on taking advantage of a 1031 Exchange, you’ll want to start looking for a replacement property just as soon as you know you want to sell your current property.

Understanding how a 1031 Exchange works

Shanae and I worked through an example of a couple who bought an investment property for $200,000 decades ago and that same property now has a market value of $2 million. If the property was depreciated at $100,0000 and the couple sold it without a 1031 Exchange, Shanae says they’d have to pay taxes on $1.9 million.

On the other hand, if they sold the original investment property and reinvested in a new investment property with a 1031 Exchange, they’d be able to defer all of the capital gains tax on the $1.9 million. Shanae says even if the couple bought down in value and the new property was $1.5 million, they’d just pay tax on the $400,000 difference. It’s pretty easy to see how that could mean some big savings.

The benefits of a 1031 Exchange

Shanae tells me the great thing about a 1031 Exchange is that it’s not just a one-time benefit. You can do multiple exchanges in your lifetime, which means you can potentially just keep deferring the capital gains tax. Shanae adds it can be especially beneficial to your heirs too. Under current tax law, they don’t have to pay back the capital gains tax that was deferred by the prior owner of the investment property.

Another thing to keep in mind is that the new property just has to be “like-kind”. In other words, the property you plan to buy does not necessarily have to be the same exact type of property you sold. You could, for example, sell a condo and still buy a single-family home, an apartment complex or a commercial property the next time around.

Can you get more than 45 days?

The short answer is no, but Shanae tells me there was a recent exception. Because of the COVID-19 pandemic last April, the IRS did issue a temporary extension for those involved in an exchange. It gave some people a little bit more time, but that’s no longer the case. As of now, there’s no extension in place. The 45 days is a hard and fast deadline. The only way to buy yourself extra time on the exchange is to delay closing on the property you’re selling.

If you’d like to reach out to Shanae for more information about the specifics of a 1031 Exchange, you can contact her at:

Shanae Mabrie | 415-987-0255 | Old Republic Exchange Company