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ASK A QUESTION
Will I have to pay Income Taxes on the Sale of my Property?
In most cases, the answer is No.
SALE OF PRINCIPAL RESIDENCE
If you are a homeowner and have lived in your home for at least two (2) of the past five (5) years and the gain in value does not
exceed $250,000.00, there will be NO TAX due.
SALE OF BUSINESS OR INVESTMENT PROPERTY
However, if you are the owner of an apartment building, shopping mall, vacant land or virtually any other kind
of business or investment property, any gain on the sale of that property is subject to taxation,
UNLESS you make use of Section 1031 of the Internal Revenue Code (IRC).
What is a §1031 Exchange?
§ 1031 of the IRC provides investors with one of the last available tax shelters by allowing them to avoid
(or, more appropriately, delay) paying any taxes when an investment property is EXCHANGED for another property.
However, there are strict guidelines and time limitations which must be observed in order to take advantage of this provision.
How Does a §1031 Exchange Work?
Rarely, if ever, do two property owners want to make an even exchange of each other's properties. Instead, most Exchanges involve four parties:
- You (the "Exchanger") who wants to sell your property (the "Relinquished Property")
- The Buyer of your Relinquished Property
- A seller (the "Exchangee") who has property that you want to buy (the "Replacement Property")
- A financial institution or title company (the "Qualified Intermediary") which acts as the link between the parties
In concept, the Buyer purchases the Replacement Property for you and then exchanges it with you. Using this device, which is allowed by IRC regulations, any gain you may have realized in the sale of your Relinquished Property is rolled over into the Replacement Property. Thus, no tax is imposed.
The sale proceeds from the sale of your Relinquished Property do not go directly to you, but get deposited into a short-term (maximum 180 days) escrow account with the Qualified Intermediary. After you have identified and are prepared to close on the Replacement Property, the escrow funds are wired and applied to pay for the Replacement Property.
Who can be a Qualified Intermediary (QI) and What are the Costs Associated with the Exchange?
There are restrictions as to who can be a QI and who can't. Basically, related parties cannot be QIs. These include your employees,
accountants, attorneys, real estate agents or brokers. Many financial institutions and title
companies are in the business of serving as QIs. Cole-Taylor Deferred Exchange Corporation is our designated QI and charges a competitive fee of $1,000.00 per Exchange
How Much Time do I Have to Identify and Acquire the Replacement Property?
You have 45 days from the date that your Relinquished Property is sold to select and identify a Replacement Property
(we recommend that you identify at least three potential Replacement Properties). You then have 180 days from the date that
your Relinquished Property is sold to actually close on one of the identified Replacement Properties.
Therefore, if you have a potential buyer ready to deal today but you have not yet found a Replacement Property, you can still proceed with the sale of your Relinquished Property to the buyer and have the proceeds placed in an escrow account. You must then select the property that you want to acquire within 45 days and must actually take title within 180 days of the closing of your Relinquished Property.
What if I Sell My Property for More than the Cost of the Replacement Property, Do I Have to Pay any Taxes?
In very basic terms, you cannot extract cash from an exchange, or if you do, it is taxable as what is termed "boot."
A successful exchange moves up in price, and up in equity, from the property sold to the property replaced. If, however,
you receive boot (money or other non-exchangeable property) in the exchange transaction, gain will be recognized to the
extent of the boot received prior to recognizing the tax deferral provisions of the exchange.
Thus, gain will be recognized and taxes will be paid on the cash received. To avoid this problem, make the exchange so that cash is not received.
What will be the Basis of the Replacement Property if I Decide to Sell it in the Future?
In tax parlance, basis refers to the net, adjusted cost of a property. In real estate, it is common for commercial property owners to depreciate the
improvements in a property over its useful life.
Lets assume that a property (Property A) that was bought for $60,000 was depreciated down to a current tax basis of $50,000. However, lets also
assume that Property A has actually appreciated in market value to $200,000.
If you were to exchange Property A for another property (Property B) of equal market value ($200,000), your old net depreciated basis of $50,000
would be transferred to Property B. In essence, the basis for Property A simply becomes the basis for Property B.
Thus, if you later sold Property B for $300,000, you would have a net gain of $250,000 (the difference between the sales price
of Property B and the $50,000 carryover basis). Once again, a §1031 Exchange can be utilized to again delay the imposition of income tax.
Can I Exchange Properties with a Family Member?
If an exchange occurs between related parties, and if either party disposes of the exchanged property within two (2) years of the
last transfer of the exchange, then gain or loss not recognized in the exchange will be recognized and taxed. The term related
parties includes any member of your immediate family, brothers, sisters, ancestors, lineal descendants and corporations
(with more than 50% controlled by related parties).
