It must be the start of a new year, tax service emails are already scurrying into inboxes like roaches across a late-night kitchen countertop. (In my opinion, both muster the same effect).
Here's some tax news that won't make you gag, shrivel, jump, or attack. It's name makes it sound like a missile, it's called a 1031 Exchange and it could torpedo your next tax bill in a good way.
Protect yourself.
Remember that feeling when you got your first paycheck? And then remember when you saw those tax line items chipping away at your hard earned dollars?
Selling a home can be exciting in the same way, especially if you make a profit in the process. Yet, when you do sell your home, you'll pay taxes on any profit made on the sale of that property too. Say what?
Taxes on property sales
Yes. Depending on your situation, you may owe the IRS money. And, according to Turbotax, how much you owe the taxman depends on "how long you owned and lived in the home before the sale and how much profit you made." But that isn't the only variable.
Whether or not the property is your primary residence affects how much dough you'll keep. So does how long you've owned and lived in the place. In most instances, to avoid a chunk of taxes, you'll need to have lived in the property for two years. Those two years don't need to be consecutive, but they do need to be within a five-year window.
Lastly, your marital status has an impact on how much you can keep without being taxed. Any gains over $250,000 are taxed if you're single, and over $500,000 are taxed if you're married and filing together.
If you sell your current place and you aren't informed, you may be left with very little to enjoy much less reinvest in your next place. This is why understanding the variables are important, and so is understanding the opportunities.
Opportunity to save
Remember how we mentioned that torpedo? The 1031 Exchange is a way to put away more money for safekeeping, so long as you spend that money on a new place.
1031 Exchanges are sometimes called Starker Exchanges or Like-Kind Exchange. This is because the money earned must be spent on another property to avoid any taxes.
This effectively makes a 1031 Exchange a swap. A powerful swap that minimizes taxes or eliminates them entirely. The swap effectively allows you to take the money from the sale of your current home and place it towards the purchase of a new place without getting hit with a significant capital gain tax.
And, it's important to note that the term 'like-property,' is quite flexible. For example, you could absolutely turn a condo into a house, or an apartment into land, etc.
So what's the catch?
There are a few limitations with 1031 Exchanges, including:
The sale money from the first property must be put in escrow while you look for that new ( or "replacement") home.
The replacement home must be purchased within six months of the sale of the old home.
The replacement home must be designated* (identified and notated) within 45 days of the sale of the old home.
That last one can be a bit tricky. You've got to get out, find, and identify property within a six and a half week window. If that sounds scary, it shouldn't. Here's the fun part. See that, asterisk? You can designate up to three potential replacement properties so long as you do close on one of those three.
Keep in mind the clock starts on finding replacement properties and on closing on your new home at the same time. This means if you take the full 45 days to designate the replacement properties, you'll have 45 days fewer left left to close.
This is where a Realtor comes in handy
Special needs like deadlines set by 1031 Exchanges are where working with an agent - and communicating your needs to your agent - become essential.
Agents, like me, will use every resource at their disposal to find you a great new place well ahead of your deadline. We can be even more effective when we help to list that first home, or at minimum, are kept in the loop as you do.
Net/Net
Simply put, 1031 Exchanges are swaps that kill taxes.
Got questions? I'd love to help you find the answers. Reach out!
Note:
It's important to note that no matter which course you chose to take when selling your home, you must report any gains when filing your taxes. This is true even when gains are excluded from your income. See an accountant for more specific information on tax returns, on your specific tax needs, and 1031 exchanges, please. And give them my card when you do.
Sources used for this article include Investopedia, Real Wealth Network, Turbo Tax, and The Balance.
Voted Neighborhood Favorite by Nextdoor, Team Cool Murphy is a top-producing, licensed real estate team based in New Orleans, brokered by Cool Murphy, LLC.
Celebrated for her next-level creative approach to real estate, Elisa Cool Murphy is an award-winning, top-performing agent in New Orleans and the founder and leader of Cool Murphy, LLC.
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