Investors in Phoenix who want to sell an income-producing property but not pay capital gains taxes have a great option that will allow them to defer that tax burden and stay active in the local rental market. This is the 1031 Exchange, and we’re talking about how that can help you sell one investment property and buy another.
Zen Rent manages single-family homes, condos, and townhouses in and around the Phoenix area, including in Mesa, Scottsdale, Chandler, and Gilbert. We can help you identify some great investment opportunities and organize your Phoenix rental property portfolio for maximum gains.
What is a 1031 Exchange?
If you’re not already familiar with this program, a 1031 Exchange allows an investor to defer capital gains taxes on an investment property when it is sold by purchasing another property with the proceeds of that first property.
So, if you decide you want to sell a rental property that you purchased for $100,000, and that property is now worth $220,000, you would have a $120,000 profit that’s subject to taxes. If you take that $120,000 and use it to buy a similar property, you can defer those taxes.
1031 Exchange Rules: Buying a Like/Kind Property
One of the most important things you have to know is that when you purchase the new property, it has to be like/kind. This doesn’t mean you can’t exchange a single-family home investment for a multi-family property investment. You can. By “like/kind,” the IRS simply means that you must exchange one income-producing property for another income-producing property. So, you cannot sell your rental property and then exchange it for a vacation home that you’ll use yourself.
1031 Exchange Timelines and Restrictions
You’ll also need to be aware of the restrictions and timelines involved in a 1031 Exchange. After you sell your investment property, you’ll have 45 days to identify a new property or properties that you want to buy. Then, you’ll have 180 days to close on the new sale. If you don’t, you’ll have to pay taxes on that initial sale.
You also won’t be able to touch that money that you’ve earned on the first sale. It goes into a separate escrow account and gets transferred over when you make the new purchase.
How an Exchange Helps Phoenix Investors
The tax benefits involved in a 1031 Exchange are pretty obvious. But, there are other good reasons to take advantage of a 1031 Exchange if you’re building your portfolio of rental properties.
For example, this is a good way to sell a rental property that has probably reached its peak in terms of performance. If you’ve noticed that maintenance costs are draining your ROI or you’re struggling to find great tenants because of the market competition, selling a rental property that you’ve had for years will allow you to make a new investment that will bring in better cash flow or attract better tenants.
You can also diversify your portfolio. This might be the best way to invest in a different type of property, for example. Selling a single-family home to buy a four-unit multiplex will allow you to collect four rent checks every month instead of just one.
There are many different ways to get a 1031 Exchange to work for you. We’d love to tell you more, so contact us at Zen Rent to talk about your Phoenix rental properties and how to maximize your cash flow and ROI.