What Is A 1031 Exchange?
In simple terms, 1031 Exchange is an Internal Revenue Code (IRC) which allows an individual or business to defer the capital gains taxes on one property to another. With a properly structured 1031 exchange an investor can reinvest these proceeds into a new property, while deferring all the capital gain taxes on any exchange of a like-kind property. As an investor sells property A to purchase property B, the value on property B has not changed. Where the value is being held is the only thing to change.
IRC Section 1031 (a)(1) states:
"No gain or loss shall be recognized on the exchange of property held for productive use in a trade or business or for investment, if such property is exchanged solely for property of like-kind which is to be held either for productive use in a trade or business or for investment."
To understand the powerful protection a 1031 exchange offers, consider the following example:
Typical Capital Gain
An investor has a $200,000 capital gain and incurs a tax liability of approximately $70,000 in combined taxes (depreciation recapture, federal and state capital gain taxes) when the property is sold. Only $130,000 remains to reinvest in another property.
Typical Investment Process
Assuming a 25% down payment and a 75% loan-to-value ratio, the seller would only be able to purchase a $520,000 new property.
Investing After A 1031 Exchange
If the same investor chose to exchange, however, he or she would be able to reinvest the entire $200,000 of equity in the purchase of $800,000 in real estate, assuming the same down payment and loan-to-value ratios.
As the above example demonstrates, exchanges protect investors from capital gain taxes as well as facilitating significant portfolio growth and increased return on investment. It is crucial to have a comprehensive knowledge of the exchange process and the IRC in order to access the full potential of these benefits. For instance, an accurate understanding of the key term like-kind - often mistakenly thought to mean the same exact types of property - can reveal possibilities that might have been dismissed or overlooked. Mission Commercial Brokerage & Investments is your resource to obtain accurate and thorough information about the entire exchange process.
Mission Commercial Brokerage & Investments would appreciate the opportunity to work with you on your next exchange regardless of how simple or complex.