Using a 1031 Exchange to “Move Up” Without Paying Capital Gains Right Away or ever? A common situation we run into is this: A homeowner wants to upgrade to a larger "forever home," but they also own a rental property they’d like to use the equity from for the new purchase. The problem? If they sell the rental, they may owe large capital gains taxes, and that tax hit can seriously reduce how much money they can roll into the next property. So naturally, the question becomes: "Is there a way around paying capital gains?" The honest answer is: you can't permanently avoid taxes, but there are strategies to legally defer them, and in certain long-term situations, the tax may effectively disappear. One of the most powerful tools is a 1031 Exchange. Real Example (Something I've Seen Multiple Times Recently) Let's say a client owns: A primary residence in North Hollywood, they plan to sell, netting about $800,000 A rental property nearby they plan to sell, also netting about $750,000 They want to buy a $2,500,000 home south of the Blvd in Sherman Oaks, and they plan to live there long-term (possibly forever). Here’s where the strategy comes in. Step 1: Use the Rental Property for a 1031 Exchange Instead of selling the rental and paying capital gains taxes immediately, they can: Sell the rental property Complete a 1031 exchange Use those proceeds to purchase the Sherman Oaks property A 1031 exchange allows an investor to defer capital gains taxes as long as the money is reinvested into another "like-kind" investment property. Important: the replacement property must be purchased initially as an investment property, not as a primary residence. Step 2: Rent Out the New Property (Required) To comply with IRS rules, the Sherman Oaks home must be treated as a rental/investment property for a period of time. Many accountants advise renting it for at least 2 years to establish legitimate investment intent. I have seen people move in and pretend that they are living at the old address, but this is not advised! Step 3: They Move Into the Sherman Oaks Home Later After renting it out for a legitimate period, they may be able to: Convert the home into their primary residence Move into the home they actually want long-term At that point, they can sell the North Hollywood primary residence they've been living in and potentially use the primary residence capital gains exclusion. Step 4: Sell the Primary Residence Tax-Free (Up to $500K) When they sell their primary home (the North Hollywood house), they may qualify for: Up to $250,000 capital gains exclusion (single) Up to $500,000 capital gains exclusion (married filing jointly) As long as they lived in the home 2 out of the last 5 years, that portion of profit may be tax-free. When they sell, the proceeds can be put into the new house to pay down the mortgage. What's the Catch? Here's the important part most people miss: A 1031 exchange does not erase taxes; it defers them. So when you eventually sell the Sherman Oaks property later, the IRS will still track the original deferred gain from the rental property. Also, if the property later becomes your primary residence, the capital gains exclusion may only apply to the portion of the gain that qualifies, depending on how long it was rented vs. lived in. Translation: Mixing a 1031 exchange with a future primary residence can reduce your taxable gain, but it doesn't automatically eliminate it. The "Forever Home" Factor (Where This Gets Interesting) This is why this strategy tends to work best when the new home truly is a long-term or forever home. Because if the homeowner keeps the property long enough, another major tax rule can come into play: What Is a "Stepped-Up Basis"? When someone passes away, their heirs may receive inherited property with a new tax basis equal to the property’s fair market value on the date of death. This is called a step-up in basis. Example: If the Sherman Oaks home was purchased for $2,800,000 and 15 years later it's worth $4,500,000… Normally, selling would create a $1,700,000 gain (and potentially a large tax bill). But if one spouse passes away and the property receives a stepped-up basis (depending on how the title is held and state law), the taxable gain may be drastically reduced, sometimes even eliminated. In simple terms: A stepped-up basis can wipe out decades of built-up capital gains. That means the original deferred gain from the rental property (from the 1031 exchange) may also disappear at death, depending on the structure and timing. This is why some families use 1031 exchanges as part of a long-term wealth strategy. Big Disclaimer (Important) This is not a loophole, and it's not something to do casually. A 1031 exchange has strict deadlines and rules, including: You must identify replacement property within 45 days You must close within 180 days The exchange must be handled through a qualified intermediary The property must be purchased and held as an investment initially And the rules about converting it into a primary residence are nuanced. Bottom line: Always consult your CPA or tax attorney before attempting this strategy. Final Thought If you have a client who is ready "move up" and is sick of dealing with rental properties, don’t assume selling it is your only option. There may be a smarter way to structure the move, but the strategy must be executed correctly and with professional tax guidance. I can walk you through the financing side and help coordinate with your CPA so the mortgage plan aligns with the tax plan. Please let me know if you have any questions or if you or any of your clients, friends, or family members need my guidance. I’m just a call, text, or email away. 📞 Direct Line: 661-291-2222 – Text OK 📞 Cell: 661-714-6258 – Text OK 📞 Office: 661-260-2970 ext. 2222 – Text OK 📧 Email: Mike@AugustaFinancial.com But wait, there’s more… Interest Rates Interest rates are a tad better today, but we’ve had a rough run over the past 10 days. Initial jobless claims came in about 10% higher than expected, which pushed rates lower this AM! Let’s hope this is a sign of good rates to come. Loan Programs We do loans on Non-warrantable condos! We offer 12-day escrows for pre-approved buyers, including conventional, FHA/Jumbo/Bridge loans. We provide loans in all 50 states, so call me with anything you need. Government loans (FHA/VA/USDA) are in the 5s. Conventional loans up to $832,750 are in the mid to high 5’s. High-balance loans from $832,751 to $1,249,125 are also in the high 5 and 6s. Jumbo loans above $1,249,125 are in the high 5’s and 6’s. ARMS in the 5’s and some in the 6’s Bank statement loans are available again with 10% down, with larger down payments in the 6’s++. Profit and Loss Statement loans require 20% down - no bank statements needed, only a profit and loss statement! 0 down loans are available in the high 6s, with a minimum credit score of 620, up to $1,325,000. Private Money lenders offer Hard Money Loans with 35% down. No-Ratio Loans require a 30% down payment. DSCR (Debt Service Coverage Ratio) loans are available with as little as 15% down. Bridge Loans typically have an interest rate of 7.99% with limited fees, helping you get where you need to go! 3/2/1 Buydowns, 2/1 Buydowns, and 1/0 Buydowns are available at great starting rates! Please note that interest rates are subject to change without notice, and the information above reflects LA County Loan Limits. **Good News for Condos:** Nada today! **Bad News for Condos*** Nothing today! CONDO HELP!!! If you have a listing or a buyer interested in a specific condo and are unsure whether it is warrantable or Non-warrantable, please call me, and we can look up Fannie’s list in real-time. We don’t know when something has changed, and it would be impossible to track everything day by day, but we don’t mind looking up a few items each day. The full state of California’s naughty list has been added to: MikeMeena.com! See the link below: https://mikemeena.com/non-warrantable-condos/ Let me know if you hear anything new about condos or townhouses. I am available every day if you need anything. 📞 Direct Line: 661-291-2222 – Text OK 📞 Cell: 661-714-6258 – Text OK 📞 Office: 661-260-2970 ext. 2222 – Text OK 📧 Email: Mike@AugustaFinancial.com Have a great day and an even better tomorrow! Please call me when you have a client who needs to borrow! Mike Meena President | Loan Officer Click to Call or Text: (661) 714-6258 This entry has 0 replies Comments are closed.
