Savvy financial minds know that it’s always smart to use the rules and loopholes to their advantage. One of the most important money-saving opportunities comes when you sell a property. If you sell a property for a gain, then you would normally have to pay tax on that property. The truly smart know there are ways around paying these kinds of taxes. You’ll have to re-invest those gains into a new property within a given period of time to defer the tax liability. It’s a smart move that can pay dividends down the road, allowing you the benefit of re-investment while allowing your dollars to grow unencumbered.
What taxes are due when you sell an investment property?
If you buy a property for $200,000 and sell it for $300,000 five years later, then you may be required to pay capital gains taxes on the $100,000 windfall. The idea is that you have made money from an investment, and that investment gain is subject to federal taxation. This is the same sort of tax you might pay if you happen to buy stock in a company and sell it for a profit a few years later.
The current tax avoidance rules respect how investors actually deal with property
It would make little sense to require investors to constantly pay taxes on their profits when they are just going to be re-investing the money in the first place. With this in mind, the existing body of laws takes into account the way investors actually spend their money. Lawmakers understand that when you sell a property for a profit, you are probably not putting that money under your mattress. You’ll be looking to eye another property that can bring in additional gains. The rules have been written to allow you to re-invest your money to avoid the tax hit. The key, though, is doing so within the appropriate timeframe.
Avoiding tax liability through a 1031 exchange
The law allows what is known as a 1031 exchange, which allows you to buy new property with the proceeds of your sale. In order to do this, you have to close on a new property within 180 days after you close the sale on your old property. As long as you do this, you can avoid the tax hit. Keep in mind that these dates deal with closing dates. This means that you will need to initiate the purchase process on your new property well before the 180-day limit. Closing can take a month or more in some cases, so you should give yourself enough lag time. If you’re making that next purchase in cash, then your closing may be accelerated, but it is not wise to take a risk.
The smartest property investors know that tax minimization is an important part of their process. You should be intentional not only with what you buy and sell, but also when you buy and sell. This will save you a tremendous amount of money on the back end.