• 1031 Tax Deferred Exchanges:

Why is the 1031 Tax Deferred Exchange Important to the Real Estate Investor?

An investor in real estate understands how important it is to preserve wealth and assets. In the frequently changing world of taxation, the investor is fortunate to have IRC Section 1031. This tax code allows the investor to exchange from one investment property to another and defer taxes on the gain. This means that a 1031 Exchange is a rollover of equity of like properties, rather than an avoidance of tax.  Thus the investor continues to build wealth through real estate investment, and maintains the hard earned equity.  Any tax liability through inheritance will be limited to gains from the date of the inheritor's acquisition, not during the years of ownership.  So in essence, the taxes that are saved now are never paid.

How to go about a 1031 Exchange and Guidelines Regarding the 1031 Exchange:

• Taxpayer finds a buyer and sells the property through a Qualified Intermediary.
• Taxpayer buys a replacement property through an Intermediary.
• The parties may not know each other and their properties can be in different states.
• The exchange period begins on the day the relinquished property is transferred and ends on the earlier of 180 days thereafter or the due date (including extensions) of the tax return for the taxable year in which the transfer of the relinquished property occurs.
• The taxpayer's agent, broker, attorney, accountant or family member is excluded as a qualified intermediary.

 CalculationExample:

          Current Market Value     =   $200,000.

          Mortgage                     =      80,000.        $200,000.   Current Market Value

          Equity                         =     120,000.        -150,000.   Original Purchase Price

          Depreciation Taken        =      20,000.         + 20,000.   Depreciation

          Taxable Gain on Sale      =   $ 70,000.         $ 70,000.   Taxable Gain

         Tax on Gain at 20% = 14,000 - Other expenses/loses could effect the gain

Without a Properly Executed 1031 Exchange:  Equity ($120,000.) less tax ($14,000)=$106,000 avilable towards purchase of new property.

With a Properly Executed 1031 Exchange:  If the tax-deferred exchange of the property was properly executed, Tax Will Be Deferred, and the investor will have $120,000. to use towards the purchase of a new property.

The concept of a tax deferred edxchange is easy to understand.  However, there are many details involved in an exchange that need careful consideration.  Before taking steps towards a 1031 tax-deferred exchange, we suggest consulting your CPA, attorney or tax advisor.