| 1031 Exchange Basics |
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1031 Exchange Introduction
A 1031 is a section code of the IRS which has been around since the 1920's, 1031 exchanges are the most commonly used tax deferral tool used in real estate and go by a lot of different names such as deferred exchange, like kind exchange, Starker exchange and tax free exchange just to name a few. Although named differently they all describe the same thing, any exchange of property as defined in Section 1031 of the Internal Revenue Code. The deferral treatment of capital gains given by a 1031 exchange gives a seller of property the best vehicle for preserving and building real estate wealth. The provision of the Internal Revenue Code Section 1031 allows property owners to exchange their property for other like kind property without any recognition of capital gains liability or recapture of depreciation at the time of the sale. Most people who invest in real estate or own property used for business purposes are concerned with the tax ramifications involved in the sale of their properties. If you are one of these people, or if you are considering investing in real estate, you should know about the Internal Revenue Service provision for exchanging one real estate investment for another. This real estate transaction is referred to as a 1031 Tax Deferred Exchange, and it can help real estate investors increase their assets while deferring taxes. This means that a real estate investor can defer, or possibly even avoid altogether, federal, and in many cases state, capital gains taxes. When this is considered, the benefits of a 1031 Tax Deferred Exchange are obvious as compared with the outright sale of an investment property. With proper planning, an investor can continue to exchange properties for those of greater value. They will continue growing their assets while deferring, and in many instances avoiding, taxes. What is the purpose of a 1031 exchange? A 1031 tax deferred exchange allows you to roll-over all of the proceeds received from the sale of an investment property into the purchase of one or more other like-kind investment properties. At closing, proceeds are transferred to a third party--called a facilitator or qualified intermediary--who holds them until they are used acquire the new property. A 1031 exchange is often referred to as a Starker exchange. Exchanges Allow You to Delay Capital Gains Taxes Capital gains taxes are deferred if all of the exchange funds are used to purchase like-kind investment property. The deferment is like getting an interest-free loan on the tax dollars you would have owed for a cash sale. More equity is retained, and that helps you move into properties of higher value each time you perform a 1031 exchange. The power of a 1031 Exchange: To understand the powerful protection an exchange offers, consider the following example:
To understand the powerful protection an exchange offers, consider the following: An investor has a $500,000 capital gain and incurs a tax liability of approximately $125,000 in combined taxes (depreciation recapture, federal and state capital gain taxes) when the property is sold. If the investor obtains a cash on cash return of 8% with either an exchange or a purchase, reinvesting $500,000 yields $10,000 more each year than investing the after tax $375,000. The chart below shows the differences in investment return. Foreground is return on $375K invested at 8% and background is return on $500K which would be available with an exchange. Difference at only 7 years is nearly $220K.  As the above example and chart demonstrates, exchanges protect investors from capital gain taxes and consequently facilitate significant portfolio growth through increased returns on investment by having the dollars not paid to Uncle Sam work for the investor. CA Taxable Sale vs 1031 Exchange
$86,580.00 available cash to purchase more property or properties by using a 1031 Exchange. Doing a 1031 helps you Create more wealth! |
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