It’s the holiday season and time to concentrate on family, friends and good cheer for all. There’s also one more thing that starts working its way into the deeper recesses of our brains in December – taxes.
Last year’s substantial tax overhaul resulted in a lot of people being not too happy, especially property owners. Caps on mortgage interest and local and state property taxes have homeowners and investors holding their breath waiting to see what their 2018 tax returns are going to look like. However, one of the favorite tax breaks for investors was not touched and that’s the 1031 Exchanges.
A 1031 Exchange allows you to exchange or reinvest proceeds from your original property and defer the capital gains on the profits from the sale. The exchange only applies to properties held for business or investment, therefore, your personal and primary residence is not eligible for the benefits of the exchange.
Prior to the tax overhaul properties could be exchanged for like-kind properties, which included all real property including artwork and valuable collectibles. Now, however, that part of the law has been amended to allow for only real estate to be recognized as an exchange.
Although the 1031 Exchange benefits big investors, it also can be an advantage for small investors and second home and vacation homeowners who take the time to establish their property as a rental income producing property. It’s possible to trade up your vacation home to a larger one by converting your second home from personal to business use by renting it for a specific number of days for at least two consecutive years. This is a nice way to defer the capital gains on your vacation property, which typically does not qualify for a capital gains exemption since it’s not your primary home, while still giving you the ability to purchase a larger home for your family.
There are certain criteria you have to meet to qualify for the exchange. You have 45 days from the date of the sale of the old property to identify potential replacement properties. In addition, you must acquire the new property no later than 180 days after the sale. It sounds a little complicated, but individuals use this tax break successfully multiple times and just keep rolling over the capital gains into another property. This can also be used to preserve wealth invested in real estate, which is a little more complicated.
As with any tax questions and changes, you need a competent CPA and/or tax attorney to review your particular situation before undertaking this process. And remember, your primary home is not eligible for an exchange and is subject to and also benefits from a whole different set of IRS regulations. Certainly, I have no way of knowing if 1031 Exchanges are used for investment properties and second homes on Anna Maria Island, but my guess is that the Island and its ever-increasing property values is prime for one of the IRS’s most popular exemptions.
So, while you’re sipping the eggnog and wrapping gifts, start thinking about April 15. If you plan ahead, Santa may leave you a very substantial gift in your stocking in a couple of years. Now that’s what I call a stocking stuffer.
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