While a new chapter in preconstruction investments or home-ownership through pre construction unfolds, there are many rules set in favor of the real estate investors that still applicable for the post recession era real estate transactions. One of these rules is 1031 Exchange, which through that any taxable capital gain on one property could be differed to another property if all IRS requirements are met.
To simplify this code, any capital gain is taxable unless the capital gain is used to acquire another “like-kind” property. Please note that this is not forgiveness of the tax amount but the payment of tax is postponed to a future date. To qualify for 1031 Exchange there are many guideline set by IRS that are detrimental in a successful Exchange.
The deferred tax allows investors to have more funds for a new investments. This method can help a pre construction investor to acquire more properties and create a smart real estate portfolio. The following example will demonstrate the mechanism of the 1031 exchange in relation to pre construction investments along with some of the rules and timeline. There is an investor who purchased a pre construction unit for $100,000 and planning to sell the same unit for $120,000. The first step prior to the sale of this unit is to hire the services of a 1031 Exchange Company or as it called a “Qualified Intermediary” or (QI). Since according to regulations the seller could not have possession of the proceed of the sale at any time, this is crucial to a correct implementation of the exchange.
Upon closing of the sales the exchange company will hold the proceed and seller has no access to that. Seller has 45 days to identify the exchange property or properties and 180 days to complete the transaction. The number and value of the future purchase are set through what is known as three rules that:
1)- Seller/taxpayer could identify as many properties as he wishes but has to purchase a minimum 95% of the aggregate value of the identified properties.
2) Seller/taxpayer will identify as many property but could not exceed the 200% or twice the value of the relinquished property.
3) Seller/taxpayer will identify up to 3 properties regardless of the value
During the Qualified intermediary Company will have the possession of the proceed and will disburse them for only upon closing on the exchange property.
In our example the seller will sell the unit that he had bought in pre construction phase through the Qualified Intermediary Company. To take advantage of the deferred tax, he will identify one or number of other properties and close on them on a timely manner. If played by the rules the investor in our example could search for pre construction investments that are in the later phases of the construction. If he could close within 180 days of the exchange period, he had benefited from the gain on the first pre-construction purchase, without paying the capital gain tax on $20,000 and used the gain plus the deferred taxes to buy one or more pre-construction units with a chance of another gain during the future sales.
The 1031 Exchange as other tax related transactions shall only be handled by authorized firms and individuals. The author is not a QI or a tax accountant and as a real estate broker shares the experience that he had gained through his involvement of sales and purchase of exchange qualified properties. For tax benefits and the latest updates on the 1031 exchange code, please contact professionals who are authorized to assist you to benefit from this great tax benefit. We also found the website for 1031.org extremely helpful and the FAQ section of the web site a perfect source to gather useful information.
