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A tax-savvy way to improve one’s real estate situation is to swap one property for a new one. Called a 1031 exchange, referring to its section of the tax code, this works so long as the individual is switching business properties. Personal residences aren't eligible.

While 1031 exchanges are often used by big commercial real estate operators, there's nothing stopping an individual from using the strategy for much smaller-scale holdings. The maneuver defers capital gains taxes, perhaps forever.

This takes some planning. For instance, say an individual has a vacation house and would like to exchange it for a property in a location that is closer to their primary residence. They must rent the original vacation place out for at least 14 days per year for two successive years, and in the eyes of the IRS, they have a business asset. The only caveat is that they must continue to rent out the new vacation house for 14 days over the next two back-to-back years.

A couple of more requirements: First, an individual must identify the substitute property within 45 days of selling the old real estate. Second, they need to buy the new property within 180 days of their sale.

The nice thing about 1031 exchanges is that one isn’t confined to the exact same type of property. So, they can swap a condominium for a farm, or a house for a marina — as long as it's a business or investment property. An Individual will need expert advice on this issue.

The December 2017 tax-code rewrite barred applying Section 1031 to make tax-free exchanges of collectibles but left intact tax-free exchanges for business- or investment-purpose real estate.

Federal Long-Term Capital Gains Income Taxes now are 15.0% (for individual filers with taxable income of $38,601 to $425,800) or 20.0% (for individual filers with taxable income of $425,801 or more). An individual can postpone paying Income Taxes on that property for the rest of their life. And their heirs benefit, too. When they inherit the property, they get a "stepped-up basis." This means the property is valued at the market rate at the time of the individual’s death. So, the taxable amount adjusts upward. If their heirs turn around and sell it right away, they will owe little or nothing. The tax liability on the property is erased.

Of course, the swap must be a sensible business deal. Getting a tax-free sale of a profitable strip mall to buy an apartment building that has trouble keeping tenants, for example, would be a bad outcome.

Accounting for the value of a property properly is another important consideration, separating a capital investment in new appliances, for instance, from the fair value of the property.

Keeping Uncle Sam's hands off the proceeds of a sale of real estate is an essential part of financial planning for owners of real estate for business, investment, or rental purposes, as well as those who rent out a vacation home.

Strict timing limitations are required in a 1031 exchange. If a 1031 exchange is not properly constructed and executed in a timely manner, then an investor could lose all tax benefits of the transaction, including depreciation recapture. In addition, the property the individual sells must be replaced with a like-kind property, and a Qualified Intermediary, as an independent third party, is needed to facilitate a 1031 exchange transaction and hold the funds on behalf of the investor.

Investors must also be leery of investments in private offerings created to sell 1031 exchange transactions. These are often illiquid investments, and do not offer guarantees of income or that one’s investment objectives will be met. They may be speculative, and one could lose some, or all, of their principal investment.

This is neither an offer to sell nor a solicitation to buy any security, which may be made only in an official offering memorandum. Investors should read any offering memorandum and review any risks associated. This article does not include all material information to determine whether to conduct a 1031 exchange.

Please note that the reader should discuss all strategies stated above with their accountant and/or legal advisor before implementing any of the above listed strategies.

Legend Financial Advisors, Inc.® (Legend) is not a tax or legal advisor. It is Legend’s intention to merely present ideas and strategies to readers to discuss with their own tax and legal advisors or in conjunction with Legend’s advisors.

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