As a military member, the largest difficulty I had was finding the best places to invest in real estate.  I moved every 1 to 3 years, so I didn’t have an obvious choice.  Through a lot of trial and error, I figured out a system that has worked well for me.  It goes against the conventional wisdom on picking the best markets for real estate investing.  That’s why it works!

How to Find the Best Markets

The secret to finding the best places to invest, especially in this advanced real estate cycle, is two things.  First, you must gain a strong knowledge of the market you are going to invest in.  This means you or somebody you trust needs to be your boots on the ground in that location.  This will allow you to buy the right house in the right neighborhood in any city you end up choosing.  Second, prioritize cash flow over appreciation.  Make sure the property you buy will cash flow well, and never sacrifice that for a hope that you will get a large amount of appreciation.

Finding the Best Cities to Invest – Common Advice

To understand the significance of the advice I’m giving, I want to share the advice every other website would give you if you googled “How to choose the best city for real estate investing.”

O yeah.  I’ll also tell you why those websites are all wrong.

All the other websites will tell you the most important things to consider in choosing a real estate market to invest in are items such as these:

1.  Population Growth

2.  Job Growth

3.  Housing Appreciation

4.  Low Unemployment

5.  Low Rental Vacancies

These blogs will sometimes teach you how to lookup these statistics showing you which websites to use so you can pick the best markets to invest in real estate.

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The 1031 exchange (26 U.S. Code 1031), otherwise known as a like-kind exchange, or Starker exchange, is one of the most important tools for a real estate investor.  I’ve seen too many military members not aware of this rule. 

I’ve actually talked with military members who have sold their investment properties and had no idea they could defer the capital gains through this exchange.  I don’t want this to happen to anyone.

Let’s get clear on it!

CAPITAL GAINS

When you sell real estate, Uncle Sam wants it’s cut of your profits.

There are only two ways to avoid paying the profits, or capital gains, on a real estate sale.

One exception is for homeowners who have met certain requirements with their primary residence, namely you’ve lived in the property 2 of the last 5 years (2 of the last 15 for military).

The other exception is for real estate investors, which we are focusing on with the 1031 exchange.

1031 EXCHANGE

The 1031 exchange got its name from the section of the IRS tax code it comes from.  This is the section that allows for a like-kind exchange that defers the tax liability of the sale into the next asset. 

Keep in mind, the 1031 exchange, or “like-kind” exchange used to apply to items other than real estate.  As of December 2017, a tax reform law that passed limits exchanges to only real estate.

You may also hear the exchange called a Starker Exchange named after T.J. Starker, who successfully sued the U.S. government in 1979. 

Before that, the exchange of real estate actually had to be simultaneous.  Now, you can typically have 180 days between the sale of the property and the purchase of the replacement property. 

Thanks Mr. Starker!

8 CRUCIAL RULES

1) LIKE-KIND

First, we need to understand what type of real estate can be substituted for what.

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You may not have to pay tax on all or part of the gain from the sale of your main home.  This is where you live most of the time.  A main home can be a:

• House
• Houseboat (cool!)
• Mobile home
• Cooperative apartment
• Condominium

Actually, everybody can get this break on capital gains on the sale of a home under certain circumstances, but military members get an additional benefit that makes it much easier to meet the requirements.

WHAT IS THE CAPITAL GAINS TAX?

Cars, stocks, and bonds are capital assets.  A home is also considered a capital asset because it is a significant piece of property.  When you sell it for more than you paid, it’s called a capital gain.

When you sell a stock for more than you paid, you’ll need to report that to the IRS and pay taxes on the capital gain.  Primary homes get excluded from this as long as it fits certain criteria called the ownership and use test.

OWNERSHIP AND USE TEST

To be eligible for excluding capital gains on your primary residence, you must be the ownership and use test, as outlined in Publication 3 – Armed Forces Tax Guide.  You will be eligible for the exclusion if, during the 5-year period ending on the date of sale, you:

• Owned the home for at least 2 years (the ownership test)
• Lived in the home as your main home for at least 2 years (the use test)

If you don’t fully meet these two tests, you still may be eligible for a partial exclusion.  See IRS Pub. 523 for more details, and consult a smart tax advisor.

This is commonly explained as you have lived in your primary residence 2 of the last 5 years.

HOW MUCH CAN YOU EXCLUDE?

It seems like it should be unlimited, right?

Dream on.  The USGOV would never allow that!

You can exclude up to $250,000 of capital gains if filing single / $500,000 if filing jointly. 

This exclusion is allowed each time you sell your main home, but generally not more than once every two years.

WHERE MEMBERS OF ARMED FORCES GET AN ADDITIONAL BENEFIT

Here’s the good part!

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