As an investor, you are probably constantly thinking about ways to improve the Return on Investment (ROI) on your Seattle rental. One of the ways many investors use to upgrade to a newer and better property is using the 1031 Exchange.
A 1031 Exchange allows you to sell your existing investment property and buy a like-kind property while deferring the capital gains taxes you would have to pay on profits while selling your existing property. This is a good option for the Seattle market, which is expensive and competitive to enter.
Protecting your wealth is an important part of investing in Seattle real estate. Here’s how you can decide if the 1031 Exchange is the tool you should be using to achieve that goal.
What is a 1031 Exchange?
A 1031 exchange is mentioned under Section 1031 of the U. S. Internal Revenue Code. It allows investment property owners to defer the taxes that may be due on the sale of a property by investing those profits into the purchase of another property, within a limited time.
When you sell a rental property, without taking advantage of a 1031 exchange you’ll be responsible for paying capital gains taxes on your earnings. But, if you’re willing to use the proceeds from the sale of your property to buy another income-producing property, you won’t lose any of that profit to taxes.
How to Perform a 1031 Exchange: Rules and Timelines
There are certain rules and timelines you need to follow if you are planning to make a 1031 exchange. For specific advice as to whether a 1031 exchange is best for your particular situation consult your tax advisor. There are some high level rules that you should understand below is a summary of some of those rules:
- You have to exchange like-kind properties. This means you need to sell one income-producing property to buy another income-producing property with a value that matches or exceeds the property you’ve sold.
- In Seattle, this means that when you sell a property and earn $400,000 in profit, you have to use that $400,000 to buy another rental property or several rental properties of equal or greater value. You can sell one single-family home and buy three condo units. Or, you can sell a multi-family building and buy two single-family homes. The properties don’t have to be exactly alike, exchanging a residential property for commercial or single family for multi-family are each acceptable examples of like-kind real property exchanges, but they do have to be investment properties. The tax-payer cannot live in the properties.
- You have to identify the property or properties you want to buy within 45 days of closing on the property you sold. In addition, you have to close on the new property transaction within 180 days of selling the original property, else you will be liable for taxes.
- Under Section 1031, any proceeds you receive from either of these transactions are taxable. Hence, all proceeds from the sale of the property have to be transferred to a qualified intermediary, not to you directly. The qualified intermediary is supposed to transfer the necessary funds to the seller of the replacement property. In addition, the intermediary should not be related in any personal or professional capacity with the parties exchanging the properties.
When Should You Consider a 1031 Exchange for Your Seattle Investment Property?
As an investor in Seattle, you can consider a 1031 exchange for your property when,
- You are looking for a way to upgrade your existing property to one that offers more ROI
- You are planning to diversify your investment portfolio
- You want to exchange your property to one or several with increased cash-flow, so you can hire a professional Seattle property manager rather than managing it yourself
- You want to consolidate several properties into one; for instance, you want to sell several single-family homes to buy a larger and more profitable multi-family building or commercial property, or vice versa.
- You need to reset the depreciation clock
Benefits of the 1031 Exchange
There are several benefits for Seattle investors who use the 1031 Exchange process. Most importantly, it allows you to dispose of your existing property and invest in a better one without paying capital gains taxes. Other benefits include:
- You can increase the number of assets in your portfolio. When you sell one property and make a lot of money, you can use the proceeds to buy two or three properties instead of just one. This provides you with additional rental income streams.
- You can save on maintenance costs. If a particular rental property is not giving you enough ROI because of increased maintenance and repair costs or large upcoming capital expenditures , you can take it out of your portfolio and replace it with a newer property that has lesser expenses.
- You can continue to invest in the Seattle real estate market. Many investors hesitate to sell a property in Seattle because they don’t think they’d be able to re-enter a market that’s growing less affordable. With a 1031 Exchange, you can sell that property and continue investing in real estate that will appreciate in value.
We help and empower investors to be more successful with their rental properties. If you need think a 1031 exchange may be right for you, need a referral to a qualified intermediary, or have any specific questions about how to improve and grow your portfolio with the 1031 Exchange or anything pertaining to real estate investing and/or property management in Seattle, contact us at ACRES Property Management. We provide residential property management services to owners and investors in Seattle as well as Tacoma, Burien, Normandy Park, Des Moines, Federal Way, and surrounding areas.