Retire in your 1031 exchange home

Here is a true story that happens all of the time. My friend bought a rental house 25 years ago as an investment for $80,000. Over the years he kept it rented and any repairs needed came from the rental income. Plus, as with any real estate investment, he was able to use depreciation each year to reduce the Federal Income tax he paid. Five years ago he sold the property for $200,000 and because of depreciation, the cost basis was close to zero. So, ordinarily he would have to pay capital gains tax on the entire $200,000 (over $30,000 in tax). However, with the help and advice of his CPA, he decided to use the IRS deferred exchange (IRC section 1031), known as a ‘1031 exchange’ to defer the tax owed. This allows you to sell, then buy a ‘like-kind property’ to defer the tax. In this case, he found a property in a retirement city (which happens to be on a few of the retirement lists in my last blog). He bought the new property for $300,000 to rent out for over three years, which is required. He made $40,000 of improvements to make the property beautiful and this amount was written off as an expense of the investment (further lowering his income tax).  Now at age 67, he has moved into the property as his primary residence. No tax is due until the property is sold. He plans to live there the rest of his life. I’ve mentioned this story to a few people and their response was ‘who comes up with these complicated rules and to what advantage’. There are a lot of income tax benefits to owning real estate, this is just one of them.

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