Everyone wants to (or wishes they could) own property in Los Angeles.
Prices seem to never go down, old neighborhoods are rich in equity, new neighborhoods are teeming with tech money and young professionals. It is an ideal environment for investors to net big returns.
For those serious about property investment, there is a little section in the IRS tax code that can be a big benefit. What’s known as a 1031 Exchange (based on Internal Revenue Code § 1031) is a way for an investor to exchange one investment property for another investment property without paying (actually, by deferring) capital gains tax.
Say you own a Strip Mall in Van Nuys that you bought cheaply in 2002. You now want out of the Strip Mall business and instead want to buy an apartment building in North Hollywood which is more expensive than the current value of the Strip Mall. If you sold the Strip Mall to use the proceeds to buy the apartment building, you would still have to pay capital gains tax on the profits you earned from the Strip Mall’s increase in value since 2002.
Using a 1031 Exchange, you can essentially “swap” the properties and avoid paying capital gains tax on the sale of the Strip Mall. That does not mean it’s a total tax exemption, but at least while those sale funds are tied up in other investment properties, they are free from federal capital gains taxation.
1031 Exchanges apply only to swapping investment properties of a “like kind.” 1031’s do not apply to primary homes, second homes, or even flipped properties. The IRS wants to see that your intent is to hold an investment property for a length of time to collect rental income and the like, before selling to buy another investment property. Essentially, the incentive is for legitimate investors to keep funds parked in investment property, not to provide random property owners an easy tax break.
The process of a 1031 Exchange is rigid and complex, as one might expect from the IRS. An experienced business lawyer can help guide you through the process. Shenon Law is here to help with 1031 Exchanges and other legal challenges facing you and your business.