What Does a Sacramento Property Owner Need to Know About a 1031 Exchange

Selling a rental property means paying taxes. While many investors simply consider that to be the cost of doing business, there’s a way to grow your investment portfolio and delay the payment of those taxes. It’s called a 1031 Exchange. This program allows you to defer those capital gains taxes if you reinvest the earnings from your sale into another purchase. 

This is an excellent way to stay in the Sacramento market and reduce your tax liability. 

There’s a lot you need to know, however. While a 1031 Exchange allows you to keep more of the money you’ve earned and establish a more effective long-term investment strategy, you have to follow its specific rules and timelines. 

Here’s what you need to know.   

Benefits of a 1031 Exchange in Sacramento

To defer those taxes on the sale of your rental property, you can buy a new investment property – or several properties – that are similar to the one you’re selling. Similar does not mean exactly the same. You can sell one single-family home and buy two condos. Or, you can sell one apartment building and buy two single-family homes. There are plenty of options.

This makes sense when you know you’ll have a large tax exposure from the sale of your investment property. Perhaps you bought a single-family rental home for $200,000 10 years ago, and now you’re able to sell it for $500,000. The $300,000 profit will be taxed. In this situation, a 1031 Exchange will save you quite a bit. 

You will also benefit from the 1031 Exchange if your rental property is older and in constant need of maintenance. Selling a home with ongoing repairs will allow you to reinvest the proceeds into a newer property that will provide better cash flow. 

How to Take Advantage of a 1031 Exchange

Specific steps need to be taken when you want to defer your taxes with a 1031 exchange. 

• Make sure your property qualifies for this benefit. This tax program is meant for investment homes. You cannot sell the home you’ve been living in and reinvest the money to buy a vacation home. 
• You’ll need to exchange with a like property or properties. The new property you choose must have a value that is the same or higher than the original property. If you walk away from the exchange with any profit, they will be taxable. 
• Find one property, two properties, or three to exchange with your current property. 
• Use an intermediary and don’t take any of the cash from the sale of your property. The intermediary will hold your funds until they can be reinvested in your new purchase. Ask your Sacramento property managers for a referral. 

Timelines for the 1031 Exchange

There are critical deadlines included in this transaction, so pay attention to the timelines. 

You’ll need to identify a replacement property within 45 days of selling your original property. This doesn’t mean you have to buy it - you simply must identify it. Then, you have 180 days to close on the new sale. The entire exchange must take place within the 180 days (meaning you don’t have 45 days plus 180 days – the clock does not reset).

The 1031 Exchange is one good way to keep all of the money you earn off the sale of an investment. Remember this isn’t a completely tax-free option. You are technically deferring the payment of your taxes. However, the current law allows you to do a 1031 Exchange as many times as you want. If you want to leave your investment property to your children or beneficiaries after you die, they’ll receive a step-up, which will let them avoid all the taxes you deferred.