The 95% rule in a 1031 exchange is a critical component of the US tax law that allows investors to defer paying capital gains tax on the sale of an investment property. Essentially, this rule states that in order to qualify for tax deferment, the proceeds from the sale of investment property must be reinvested into a “like-kind” property within 180 days, and 95% of the proceeds must be invested in the new property. The remaining 5% can be taken as cash without triggering a taxable event.
- The 95% rule applies to all 1031 exchange transactions.
- The rule requires that 95% of the proceeds from the sale of the old property be invested in the new property.
- The remaining 5% can be taken as cash without triggering a taxable event.
Suppose an investor sells an investment property for $500,000. To defer paying capital gains tax, they must reinvest the proceeds into a new like-kind property. Under the 95% rule, they must invest at least $475,000 (95% of $500,000) in the new property. The remaining $25,000 can be taken as cash.
- Make sure you clearly understand the definition of like-kind property.
- Work with a qualified 1031 exchange intermediary to ensure you comply with the rule.
- Have a clear plan for reinvesting the proceeds from the sale of the old property.
The 95% rule is an essential component of the 1031 exchange process that allows investors to defer paying capital gains tax on the sale of an investment property. By following the guidelines set forth in the rule, investors can ensure they comply with tax laws and maximize the benefits of a 1031 exchange. It’s essential to work with a professional and have a clear plan to ensure you comply with the rule and successfully defer capital gains tax.
