Trading real estate, perhaps better known as “house flipping,” is something that’s become huge, with over 207,000 homes being flipped in 2017, reports CNBC. The process of flipping involves an investor purchasing a home, making renovations, and then selling the property, typically in under 12 months. Trading investment real estate (exchanging the sale of one property for the purchase of another property), such as Atlanta real estate, allows the investor to defer the tax consequences, or capital gains tax, through the 1031 exchange.
Be sure to follow these guidelines to ensure your trade meets the requirements for the 1031 exchange.
Know Your Timeline
When flipping and purchasing a new investment property, you must follow the strict 45- and 180-day guidelines. What this means is that you have 45 days after the sale of your original property to identify a new property of equal or greater value. Once you have found the home, you then have to purchase the home within 180 days from the time the initial property sold. For example, if you sold your home on May 1st, and you located a home on May 30th, you would have 150 days remaining to close the sale. Many investors look to have an immediate trade, where they close on one home and purchase the second on the same day.
Must Be Equal or Greater Debt and Equity
In order to take advantage of the 1031 and defer 100 percent of the capital gains tax, you need to use all the equity and replace all the debt in the exchange. For example, if you sell a home for $250,000 that has $100,000 debt and $150,000 equity, you must purchase a home that is at least $250,000.
Properties Must Be of ‘Like-Kind’
In order for a real estate trade to qualify for a 1031 exchange, both properties must be of like-kind. This typically isn’t a problem in the world of house flipping, as most investors are going from one home to another. However, in most cases you are not limited to single family homes. You can exchange a home for an apartment or condo, for example.
The Property Must Be for Investment Only
The home you choose to trade for must be for investment only. Again, this is typically not an issue for house flippers as their home purchase is typically designed to be another home they intend to flip. However, you must know if you decide to purchase a home for personal use, that will not qualify. It goes the other way as well. You can’t start out your home-flipping with the sale of your personal home and qualify for the 1031 exchange.
You Must Use a Qualified Intermediary for the Sale
A 1031 exchange has strict guidelines that you may not take possession of any cash from the sale of your initial property. Doing so is considered constructive receipt and will subject you to tax. For this reason, you must use a qualified intermediary to handle the sale and hold the proceeds until they can be used for the purchase of the second property. They will then handle the purchase.
Taking advantage of real estate trading and the 1031 exchange can be beneficial for house flipping investors, but in order to take full advantage, it is essential to follow these guidelines.