December 1, 2006
Making 250k Tax Free Per Year-MUST READ
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Here is a tax code not many people know about. It’s called the Internal Revenue Code 1031. This is a huge money making possibility for real estate investors. The IRC 1031 has a serious tax advantage to land exchanges for commercial and real estate investing. This kind of land exchange, also known as the Starker Exchange, can defer capital gains taxes on �like kind� investments in real estate.
What does “like kind” mean? “Properties are of like-kind, if they are of the same nature or character, even if they differ in grade or quality. Personal properties of a like class are like-kind properties. However, livestock of different sexes are not like-kind properties. Also, personal property used predominantly in the United States and personal property used predominantly outside the United States are not like-kind properties.
Real properties generally are of like-kind, regardless of whether the properties are improved or unimproved. However, real property in the United States and real property outside the United States are not like-kind properties.” That is pretty broad, leaving the investors with a ton of money making potential.
This is the gist of how a 1031 works. I will show you how you and your spouse can make $250,000 per year with real estate.
Say Jim wants to sell his investment property, a log cabin in North Georgia, to Taylor. Jim purchased the property for $600,000 dollars four years ago, and is now selling it for $900,000. He would have to pay $300,000 on the capital gain from that sale. Jim finds a qualified intermediary, a third party who facilitates an exchange of property, and pays them to harbor his $900,000 from the sale. Jim now has to find another investment property within 45 days and purchase one by 180 days from the exchange. Jim finds a beach house in Florida for $800,000 and throws in the other $100,000 for upgrades. Jim has now differed his taxes and didn’t have to pay a penny right now.
Now this is a wonderful use of our extremely complicated tax system, but I guess the IRS wants us to educate ourselves to become rich. You might be asking yourself “I want to know about making $250,000 per year!” Well here is comes! Let’s just say Jim decides to sell his beach property and purchases three other pieces of real estate that cost him $350,000 each. Jim has the money because he sold the beach property for 1.2 million anyways. Jim goes through another 1031 exchange and buys the three properties. Jim rents the houses for a few years, and then lives in one of them for two. The house has now become a personal residence and can be sold tax free.
Jim’s first property, which he currently lives in with his wife, is now selling for $500,000. That’s a $150,000 gain (Paid 350k and selling for 500k); which he would have to pay taxes on that until the Taxpayer Relief Act of 1997 came into law. He can now sell that house for $500,000 TAX FREE, and move to his other investment property, live in it for two years and do the whole process over again.
Jim turned a $300,000 tax liability to a tax free $250,000 per year income generator. Not a bad deal. Could you deal with earning $250,000 of tax-free money per year?
This makes a huge assumption that real estate prices are going up and that they are going up significantly. Can you show an example of how this works in market with stagnating or declining real estate prices?
It does sound like an interesting loophole, but I’d talk to a tax advisor first before implementing this plan. It seems to me that you’d have to pay some taxes along the line. I fully understand what you are trying to do, but something says there may be an exemption on the 500K tax exemption if it was bought with tax deferred money.
Declining markets in the real estate business rarely happens especially in “nvestment”properties. Yes it happens, but rarely. But if it were to happen you can write off the loss on your taxes if you sell an investment property*not your principle residence*.
It’s really not a loophole. It’ a tax code. Of course you would want to talk to a tax advisor, but this has been a great way for people to make money in real estate. But you NEVER pay taxes on a deferred tax asset until you cash it out. If you switch the investment property to a primary residence the 1997 tax law allows the selling of a property of 500k is tax free. If you were to sell the property for let’s say 600k, you would be liable for taxes on the 100k if you lived at the residence 2 out of 5 years.
When you say declining markets in real estate business rarely happen in “investment” properties, do you mean commercial properties?
The investment property that I have in the Boston suburbs is worth less now than it was 3 years ago. And it’s far enough in the negative, that I don’t expect it will be back to even for another two years — if those are are great years in Boston. That’s 5 years where it’s declining or even. How rare is rare when it’s 5 years in a row?
I see it as a loophole as you are not paying on the basis of the property — the 350k, that you “deferred.” I see why you wouldn’t have to pay that, but it’s something that I’d surely want to confirm with not one, but several tax advisors.
1031 exchanges can work fine, and are used frequently. Let’s just make sure the terminology is correct; as Lazy Man mentioned, the gains will be taxed eventually, as they are only deferred. Also, in the original case of a property being worth $900,000 with a basis of $300,000, the taxpayer would only pay long-term capital gains on $300,000 of appreciation, which would currently work out to a tax liability of $45,000. Unfortunately, the basis in the new property would only be $600,000, which the taxpayer then depreciates. The problem I’ve seen is that people will go out of their way to buy unattractive properties just to have a place to ‘defer’ their taxes, which does not make economic sense.
I think you are assuming that you selling the property as a investment property; instead of turning it into a personal residence. From what the law says and my real estate law book, you can 1031 and break down the homes to avoid tax situations. By turning an investment property into a personal residence the Taxpayer Relief Act of 1997 exempted from taxation profits on the sale of a personal residence of up to $500,000 for married couples filing jointly and $250,000 for singles.