You find yourself as a owner of more than one property in the Bay Area and you are wondering what to do next. First, congratulate yourself. For most it is hard to become an owner of one home in the area much less more than one. Maybe this was your first home, many years ago, or maybe it was an inherited property. Either way, it has a low mortgage, if any, and has a low tax base. You have been renting it out for the last couple of years and now you’re wondering what is the next best step. If you sell it you have the potential to be taxed nearly 30-35% (15% Federal Capital Gain Tax for assets held > 1 year, 9.3% State Capital Gain Tax, 25% Depreciation Recapture Tax). But there are options.
One option involves utilizing the 1031 Exchangetax code. According to my friend Leonard Spoto at Asset Exchange Company based in San Francisco, most investors exchange for several reasons:
- the ability to defer taxes,
- leverage existing equity to buy a larger property or a property with higher value potential,
- to diversify their real estate holdings,
- to gain relief from management burden
- to exchange a fully depreciated property to a higher value property that can be depreciated.
Of course if you have heard anything about 1031 Exchanges you have heard the term, “like kind”. Like kind simply means that the property is “held for productive use in trade or business or for investment.” Currently, foreign property does not qualify as “like kind”. If your rental (investment) property is a single family residence, you can exchange it for an apartment complex, a shopping mall, multiple condominiums, or whatever – excluding foreign property. The key phrase here is “investment”.
Next you have to realize that with a 1031 exchange, “all cash from the sale must be reinvested” and that you should purchase a property equal or greater in value.
Then the next constraint is the time line. The time line is critical because the IRS does not accept, “oops” as a reason for not completing your time line requirements. Missing deadlines = capital gains on the sale. Period. The end. According to Asset Exchange Company you have, “180 days – or until your taxes are due for the year for the exchange to be completed. You also have a 45-day deadline in which the exchange properties must be identified.”
There are many reasons why a 1031 Exchange may be the right decision for you and your property. The reason to consider a 1031 Exchange is that it offers options for you to continue your investment in real estate beyond your current real estate holdings. If you are interested in learning more about 1031 Exchanges, please contact me.