What is a 1031 Exchange?
Posted by Andy Gustafson on Fri, Apr 23, 2010
Internal Revenue Code §1031 represents the ability to defer Federal capital gains and recaptured depreciation taxes when selling real or personal property held for investment or in the production of income or in a business and replacing with real or personal property held for investment or in the production of income or in a business.
By deferring the tax, the Exchangor is able to use the tax deferred as additional capital towards the purchase of more real or personal property. Rather than paying the tax which is then deferred until the sale of the replacement property, the gain or the dollars it represents can be used to purchase a greater value of property, thus maximizing the marginal use of each taxable dollar.
Ok, so what does this mean? Given a rental property purchased for $50,000 with a $25,000 loan and later after ten years sold for $150,000. The structure is valued at $25,000 and was depreciated each year totaling $9,091. Selling expenses include realtor sales commission, title insurance and other associated closing expenses of $13,500. The total capital gain is $95,591.
If a 1031 exchange is initiated, the total tax deferred is $15,248 (recaptured depreciation of $2,273 + Federal capital gain $12,975). Rather than exiting the closing with after tax equity of $96,252, initiate a 1031 exchange reinvesting $150,000 or more in the replacement property and allow the $15,248 to continue to work in your interest. Effectively, the 1031 is an interest free loan of $15,248 allowing a cash infusion to fund new opportunities.
1031 exchange rules are strictly followed in accordance with the Internal Revenue Code Section 1.1031.
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