Fix and flip? 1031 exchange defers capital gains tax

It seems as though everywhere we turn nowadays we can read about someone making money in real estate -- from reality TV shows to books on how to make it as an entrepreneur, everyone is trying to make it in the real estate business.

There are definitely risks associated with investing in real estate, but with big risks can come big rewards. There are several different ways that people can make money in real estate, including owning and renting income properties as well as buying cheap properties, fixing them up and selling them at a profit. However, if you aren't careful with your real estate transactions, you can quickly see your profits being turned over to Uncle Sam the tax man -- unless you take advantage of a 1031 exchange on a fix and flip.

What is a 1031 exchange?

A 1031 exchange on a fix and flip allows real estate investors to rollover their gains from the sale of one property into the purchase of the next property. This is a major advantage for real estate investors because it allows people to defer their capital gains taxes until the sale of the next property.

Can everyone qualify for a 1031 exchange?

Not every property sale qualifies for a 1031 exchange on a fix and flip. To qualify for a tax deferral your entire transaction must be structured in a very certain way from the beginning to the end. You must meet certain conditions, which the IRS strictly enforces, including the following:

• Both the property being sold and the property being purchased have to be purchased and held strictly for investment purposes. This includes rental properties as well as buying properties and holding them for the increased value over time.

• The transactions of selling and buying have to be within 180 days of each other; otherwise investors will need to declare the capital gains from the property sale.

• The main reason for the transaction cannot be for sale and profit. This means that "flippers" who buy and sell properties as their main business do not qualify for a 1031 exchange on a fix and flip.

How does the IRS decide if a real estate transaction qualifies?

If the IRS suspects that a real estate transaction does not qualify for a 1031 exchange on a fix and flip, they will examine the transaction from A to Z. Then the IRS will decide if the transaction qualifies for a capital gains deferral or if the seller has to pay tax on their profit.

The IRS takes a number of factors into consideration when evaluating real estate transactions. These factors can include the reason why you originally purchased the property, why you sold the property when you did, as well as the number of renovations that you have done to the property and the frequency with which you buy and sell real estate.

Before you jump into your next real estate transaction, make sure to structure it in a way that allows you take advantage of the 1031 exchange on a fix and flip.