Buying real estate with your IRA (or any other retirement account) is possible but it’s not going to be easy without guidance from experts in law and investments. Ideally, a person who wishes to use his or her IRA in purchasing real estate must scout for a plan administrator who will let him do so. This administrator will follow many strict rules, so you would have to do a lot of convincing to get him or her to believe that the property you want is a good investment for your IRA.
Experts advise against administrators who could be working on a commission under financial planners, who could have premeditated designs in selling their very own investments. As much as possible, look for one who would be committed to administering accounts and nothing much else. After doing so, you may then roll retirement funds onto the new retirement account.
If there’s enough cash on the new retirement account, you will be able to buy a self-supporting property. In this program, you will be getting a property that would appreciate in value over the next couple of years. Moreover, this property can generate enough gains to cover its own cost over the years. This means that you would no longer need to shell out money from other resources to pay for it.
Businesses rely on investments and assets in order to survive, although there are times when some of these go so bad that it’s time to have them removed. However, rather than go through the trouble of liquidating them and buying a new one, savvy businessmen can simply swap their old assets with new ones, and pay little for the transaction. This is known as real estate exchange.
Section 1031 of the Internal Revenue Code deals with the “exchange of property held for productive use or investment”. While this description sounds pretty straightforward, this does give some limits to 1031; it can’t be invoked to swap one residential property for another, unless it’ll be used for investment (rather than living) purposes. The term “property”, however, is very broad and can include even small things like cars and paintings.
According to the Internal Revenue Service (IRS), up to three of these properties can be designated as replacement properties, provided that the buyer makes a transaction on at least one of them. In addition to that, taxes can still apply on exchanges that involve properties with existing debts and mortgages, like office spaces. This is especially true if, say, the old property has a greater mortgage than the new one because this will mean that the buyer only has to pay off a smaller mortgage after the exchange, which is considered by the IRS as “income”.
Delayed exchanges under Section 1031 are highly popular among investors. As the name implies, there’s a time delay between the investor relinquishing their property and buying a second one. If you are considering a delayed 1031 exchange but don’t really know how to crack it, here are the steps.
The property owner seeking an exchange on his asset should first acquire a Qualified Intermediary. The party will facilitate the sale by drafting up an exchange agreement and tasking the closing agent to complete procedures on their end. The property will be directly-deeded to the buyer, but the proceeds will be temporarily held up until the owner of the now-relinquished property finds a replacement property no later than 45 days after the close.
For the identification, the exchanger will need to abide by certain rules. The Three-Property Rule allows them to pick three open properties regardless of fair market value. The 200 Percent Rule takes into account any number of properties whose aggregate fair market value shouldn’t be equal to twice their fair market value. The 95 Percent Rule applies to any number of properties regardless of fair market value as long as the person acquires 95% of the properties’ value. The replacement property itself should be secured within 180 days.
Section 1031 of the Internal Revenue Code defers taxes on like-kind exchange of properties, but what exactly qualifies as “like-kind?” By legal definition, “like-kind” means that two properties or assets involved in the exchange are of the same nature. If you don’t want your gains to be subject to capital gains tax, you need to exchange the property for another property. Don’t worry about the quality; as long as they are both properties, you’re good.
Aside from exchange, there’s also another way to benefit from a 1031. If you reinvest the gains in the sale of your property on another property, you also qualify for tax deferral on capital gains. However, it still has to be like-kind, so you can’t reinvest the gains in the sale of your property to a car and vice-versa. In addition, keep in mind that the deferral only lasts for the whole tax year, so you need to keep on reinvesting on like-kind property if you want the deferral to last longer.
Even if the properties are like-kind, Section 1031 only caters to properties and assets for productive use in trade or business. Residential homeowners, however, qualify for a 1031 as long as they turn their home into a business (e.g. rental). With this, properties and assets bought for personal use don’t qualify for a 1031.