The 1031 exchange is an outstanding and unique opportunity for Houston investors to protect themselves and their portfolio against the taxes that must be paid on capital gains when a rental property is sold. If you’re considering such a move, it’s a great way to diversify your portfolio and keep more of your earnings.
It works like this: when you sell an investment property, instead of banking the proceeds, you can reinvest those earnings into another investment property or properties. This allows you to defer the capital gains taxes you’d otherwise have to pay.
There are some pretty strict rules and timelines, however, and they are enforced in great detail by the IRS. Here’s what you need to know.
Qualifying Houston Properties
Before you can plan your 1031 exchange, you need to make sure your property qualifies. You also have to limit yourself to buying a like/kind property as your replacement. This tax benefit is only for income-producing properties. You cannot do this with the home you’ve been living in for the last decade.
When you sell your existing property, you have to exchange it for a similar property. This doesn’t mean you’re limited to buying a single-family rental home when that’s the type you sold. You can buy an apartment or a couple of condos. You can even invest in commercial space. The point is, you have to exchange income property for income property. You cannot sell a duplex you’ve been renting out and buy a vacation home that you’ll use yourself.
It’s also important to measure the value of the new home you’re purchasing. It must be worth the same amount or more than the property you’re selling.
Timelines to the 1031 Exchange
The market is hot in Houston right now, and it may take longer to find a property you want to buy. However, you have to work quickly. You must identify a replacement property within 45 days of selling your original property. Then, you have 180 days to close on the new sale.
This is 180 days total, from the sale of your initial property. You do not have 180 days from the date that you identify a replacement property.
Using an Intermediary for a 1031 Exchange
The IRS requires that you use an intermediary as a third party to hold onto the proceeds of your sale. That money should never touch your own account. The intermediary will hold your funds in escrow until they can be reinvested in your new purchase. Your intermediary shouldn’t be someone you know personally, and you can likely be referred through your real estate agent or Houston property manager.
If you do take even a portion of the money yourself, you’ll immediately be required to pay taxes on that amount. Leave the financial part of this transaction in the experienced hands of your intermediary.
This can be a complicated transaction, but it’s worth the time and energy if you’re investing in Houston rental properties and you want to grow your portfolio. For some help, please contact us at OmniKey Realty. We work with rental property owners in Houston, Dallas, San Antonio, and surrounding areas in Dallas County, Collin County, and Houston County.