Real Estate Appreciation

Written by Linda Alexander
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Sometimes, people own investment property for years while it appreciates in value. They may have taken all of the depreciation deductions to the point where selling the property will lead to a high tax bill. Instead of selling it and paying the tax, investors in this situation could use the property's equity to purchase more valuable property.

By structuring the deal as a 1031 exchange of like kind property, rather than a sale, you can defer the capital gains taxes. You can apply all of your property's appreciation toward a replacement property. To do this, it must be an exchange, rather than a sale. The relinquished and replacement properties must both be held for business or investment use. If you dispose of real estate, you must exchange it for real estate--that is what is known as "like kind" property.

You cannot exchange property that is held primarily for sale, such as inventory. It has to be property that you are holding for business or investment reasons. Experts suggest that you own the property for at least one year in order to prove that you bought it as an investment, not merely to sell it. Purchasing a fixer-upper and renovating it, then selling it three months later, for instance, would indicate intent to sell, not intent to invest.

Reverse, Simultaneous, and Deferred Exchanges

The 1031 exchange also works in reverse. Sometimes, it is easier to identify replacement property and purchase it before you sell your relinquished property. You can do a simultaneous exchange or a deferred exchange. The latter has strict rules about timing, so hire an expert to help you through the process if you intend to exchange real estate.

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