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Profiting from real estate without paying taxes

I start this column by saying that everything I am telling you here needs to be discussed with your accountant or financial adviser before you talk to your Realtor.

In 40 years as a Realtor, I have watched many dozens of people build wealth through ownership of real estate, and defer or avoid paying income taxes on it. All of this is legal under the IRS code, but there are rules you must follow.

Let’s start with your home. If you buy a home and live in it as your principal residence for more than two years, when you sell it you can make up to $250,000 profit tax free. If you are married, this can be as high as $500,000 for a couple filing together. Let’s face it: Unless you own a street corner with a traffic light on a semi-commercial street, that isn’t likely in the Mahoning Valley. However, I have witnessed very large gains in value for owner occupied residential properties over the years, and paying no income tax on it is a good thing.

If you own a “business property,” there are even greater opportunities. Let’s define a business property. A residential home that you are renting out is a business property, and so is farmland that has crops or livestock on it. A commercial building, apartment building or land with a gas well on it are considered “held for business use” and all have an interesting niche in the IRS code that allows them to be sold or “traded” without paying any income tax on the profits.

IRS Code section 1031 allows property held for business use to be sold and the income taxes on the profits deferred (not paid) if the seller then purchases another “business use property.” So if you own a rental home you purchased for $40,000 and you get an offer to sell it for $60,000, if you purchase another “business use property” for $60,000 or more, no income taxes are due.

You could sell the rental home and buy an apartment, strip plaza or vacant land that a farmer is renting and pay no taxes. A client I know is selling 100 acres of farmland and looking at buying a commercial building with all the money, so no income taxes are due. There are misconceptions that you can only “exchange” similar properties, but the IRS does not mandate this. They only must be “business use.”

Your home is not considered business use. If you hold these properties until you die, there are no Ohio estate taxes and there are limited federal estate taxes. Your heirs might never pay income tax on these investments.

This is where you need a talented Realtor who has done 1031 tax deferred exchanges. There are definite and exact rules as to how a 1031 exchange occurs. This is not a rookie’s adventure, and only skilled professionals should be consulted. Do it wrong and you lose the tax deferment, period. You need advice from your accountant and will need to work with a title attorney familiar with 1031 exchanges, but for real estate investors they are a valuable tool to build wealth while deferring or never paying income tax on the sale’s profit.

Darlene Mink-Crouse is the 2018 president of the Warren Area Board of Realtors.

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