Q: I have a rental property that I want to sell, and I want to rollover my profits to another real estate investment.
Can I invest this money in a motel? Or, can I invest this money in land, which will be developed in the future as an apartment complex or houses? Or do I have to invest the cash in another rental property?
I invest this money in condominium on the beach and when I retire, can I use tax saving by considering my primary residence and get $250,000 tax benefit?
A: Yes, yes, yes and possibly.
Real estate investments come in a number of shapes and sizes. You can buy a house, townhome, or condominium, or you can buy vacant land, a strip mall, a motel or even a multi-story apartment building. Buying land, or the buildings on that land, is considered a real estate investment by the IRS.
If you purchase one piece of investment property, like a rental condo, and you want to roll over the profits into another purchase, like a motel, you’d want to use something called a 1031 tax-free exchange, which is also known as a Starker Trust.
This allows you to defer any capital gains tax owed on any profits you’ve earned when you sell the first property. You roll these into your purchase and can continue to defer taxes for as long as you own this next property.
Starker trusts, or 1031 tax free exchanges can be a little sticky. There are specific rules about time: You have to choose the new property within 45 days of selling your current investment property and must close within 180 days. If you blow these deadlines, you’re out of luck.
You may also need an independent third party to help you set up the 1031. Talk to your real estate attorney for some referrals, but be sure you choose someone with plenty of experience.
If the attorney and third-party administrator don’t know what they’re doing, you could be stuck with the short end of the stick and owe a huge tax bill with penalties.
Your final question leads me to believe youâ€ââ€Â¢re really thinking about the long-term, so let me play along. Letâ€ââ€Â¢s say you go through several investment properties and end up owning a beautiful house on a beach somewhere as a rental.
Can you move there as your permanent residence? Sure. And as long as you live there for 2 of the previous 5 years, youâ€ââ€Â¢ll be able to take up to $250,000 in profits (up to $500,000 if youâ€ââ€Â¢re married by that time) tax free. But when you do sell, you will have to recapture the depreciation and other tax benefits you enjoyed through the years.
To embark on this journey you need not only a great real estate attorney, but a darned good tax preparer or accountant as well.
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