We all owe taxes – it’s the law, but there are plenty of legal ways to minimize your tax obligations so you aren’t handing everything over to the IRS. While there aren’t many opportunities for double tax savings – when you combine the benefit of a principal residence and the Section 1031 like-kind exchange.
How it Works
To take advantage of the tax double play, you’ll need a primary residence you turn into a rental property, and then sell within 2 years using the profits to buy (invest) in another ‘like’ property.
It starts with the primary residence capital gains exclusion. You must live in your primary residence for at least 2 of the last 5 years to use the exclusion. If you do, you can exclude up to $250,000 in capital gains if you’re a single filer and up to $500,000 if you’re married filing jointly.
Before you sell it, though, move out of the home and turn it into a rental home for 2 years, remembering that to get the capital gains exclusion the property must have been a primary residence for 2 of the last 5 years (not consecutively).
You earn cash flow while you rent the home out, and after two years, you sell the property, using the money earned to buy another property for investment purposes. This is how you qualify for the 1031 like-kind exchange and avoid paying taxes on any of the proceeds of the sale.
No matter how much profit you earn on the sale of the rental property, you defer the taxes (the difference between the profit and your capital gains exclusion), because you reinvested it in another investment property.
Keep the Savings Coming
Here’s another way to keep the savings going. If you keep the investment property you bought with the like-kind exchange until you die, you pass it down to your heirs. Their cost basis becomes the value of the property the day you died. If they sell the property right away at that value, they have no ‘profits’ and owe no taxes, allowing them to keep the entire proceeds you left for them.
Of course, this only works if your estate is worth less than $11.7 million as that’s the maximum an estate can be worth before it’s taxed.
It sounds complicated, but it’s a simple process that helps you keep much more money in your pocket, and why not – you earned it! If you’re interested in learning more about how the capital gains exclusion and 1031 like-kind exchange can benefit you, contact me today. I’d be happy to show you how you can benefit too.