Taxes are an inescapable fact of life! The real estate market is one of the biggest taxable segments. The constant search for ways to get tax exemptions in this sector, like other areas too, is endless. Property replacement is one transaction in which the real estate market offers considerable tax benefits.
Property replacement is a real estate transaction involving the sale of one property, deferring the capital gains’ tax due on that sale, by buying another property with proceeds of the first sale. Capital gains tax is a tax payable every time you sell a property for profit. Thorough planning can either eliminate or reduce capital gains tax.
Having understood what a replacement property is, here’s more information on the tax advantages you can secure with replacement property.
Deferring capital gain taxes: Tax savings through a replacement property, i.e. federal and state taxes combined, can be as high as 28% of the gain on an investment property. A properly organized property replacement can defer 100% of the federal and state capital gain taxes, which can be considered on par with a 0-interest, unlimited term loan until the property is sold for cash. In most cases, capital gain taxes are deferred indefinitely due to the continual property replacement adopted by the real estate investors, thereby increasing their investment values multifold.
Depreciation benefits: Earn multiplied revenue by the money that is saved on taxes, by investing in a property that is worth many times the initial purchase. The larger the property the greater is the cash flow, and with it comes greater depreciation benefits. This in turn increases the investor's return on their investment.
Better Management: Many investors buy several single-family units over the years, which are also taxable under the “other income sources” category. The ongoing maintenance and management of a diverse group of properties can be lessened by exchanging these multiple properties for one property better suited for maintenance and management. This can either completely avoid or at least lessen the amount of tax deductions. For instance, replacing existing properties with an apartment complex with a resident manager is sound property replacement strategy
Planning Ahead: Continue to avoid recognizing capital gains until death and avoid taxation on the premise that the taxpayer's heirs will obtain the property. Often a number of family members inherit one large property and disagree about what they want to do with it. Some want to continue holding the investment, and some desire to sell it off immediately for cash. By converting a single large property into several smaller units, an investor can make provisions for each heir to receive a different unit of property, which they can either hold or sell.
Though tax perks received through replacement property are very appealing, consulting a tax expert while acquiring a new property and/or selling an existing property is highly recommended. The tax expert with his expertise can facilitate a smooth property exchange process and also assist in utilizing and making the best of the tax exemptions that are in store!
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