What You Need To Know About 1031 Exchanges

What you need to know about 1031 exchanges, otherwise known as a tax deferred exchange or a like kind exchange.

Any real estate property owner or investor of Real Estate investment property should consider a 1031 exchange when they expect to acquire a replacement “like kind” property subsequent to the sale of any existing investment property. Anything otherwise would necessitate the payment of a capital gain tax.The main reason for a 1031 exchange is that the IRS depreciates capital real estate investments at a 3% per year rate as long as you hold the investment, until it is fully depreciated. When you sell the capital asset, the IRS will tax you on the depreciated portion as an income tax, and that would be at the marginal tax rate. If you hold an investment for 15 years , the IRS depreciates it 45%. You would pay the taxes on that 45% depreciation. If combined state and federal taxes are 35% at the marginal rate, that’s about 15% of the cost of the property, one third of 45%. If your property is fully depreciated, it becomes the whole 35% marginal tax rate.Also consider that when purchasing a replacement property (without the benefit of a 1031 exchange) your buying power is reduced to the point, that it only represents 70-80% of what it did previously. There are strict time frames between selling your investment, identifying the replacement properties and closing on those properties. An investor can sell one property and buy several to replace it, or vice versa.

The main rules to follow are:

1.The total purchase price of the replacement property must be equal to, or greater than the total net sales price of the relinquished real estate property.2. All the equity received from the sale of the relinquished real estate property must be used to acquire the replacement property.

There are variations of the exchange and the process is complicated.Any investor should consult with a specialist in 1031 exchanges when considering this option.