Deferring Capital Gain Taxes With 1031 Exchange

California real estate is known as an equity market.  Property values are growing more quickly than in the rest of the country: according to the National Association of Realtors, the national price of a single family home increased by 12.5 percent in 2013, while Santa Clara County’s median home price went up by 22.3 percent.

The side affect of this fast growth is that in case of sale your proceeds may be subject to capital gain taxes.

Most of us are aware of the home owner exemption of $250K, $500K for couples, in case of primary residence sale. For the investment properties you can use 1031 exchange to defer or completely avoid your income tax liabilities.

In order to qualify, the owner should exchange a property for a “like-kind” property and almost any real property in United States is recognized as “like-kind.”

The owner should declare the property they are selling as subject for exchange before closing the sale, identify the replacement property within 45 days of closing and acquire the replacement property within 180 days.  It is also possible to purchase the replacement property before selling by using a reversed 1031 exchange process.

1031 exchange will help you consolidate your real estate investments, move your holdings to a different area or state, or divest out of particular property types without incurring any income tax liabilities.  Multiple properties can be exchanged for a single property or multiple ones as long as all properties are used for business purposes.

Not all proceeds from the sale of the relinquished properties need to be reinvested into the replacement property.  The remaining funds will be transferred to the owner and will be taxable when received.

You also may be able to convert your primary residence into an income property and then use it in a 1031 exchange.  The replacement property then has to be rented out for a period of time before allowing the owner to move in and claim it as their new primary residence.

Michael Talis is co-owner of TALIS Real Estate.