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THE 1031 EXCHANGE
EXPLAINED
WHY IS THE 1031 TAX DEFERRED EXCHANGE
IMPORTANT TO A REAL ESTATE PROPERTY 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 the 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 the 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.
CALCULATON EXAMPLE:
| 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 affect the
gain
(A property can
be sold for less than purchased for and still have a
gain) |
WITHOUT A PROPERLY EXECUTED 1031
EXCHANGE:
Equity ($120,000) less tax
($14,000) = $106,000 available towards purchase of a 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 another investment property.
The concept of a tax deferred exchange 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, please consult your CPA,
attorney, or tax advisor.
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