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.”
So what does that exactly mean?
Basically, a properly structured 1031 tax-free exchange allows an investor to sell a property, then reinvest the proceeds in a new property, and then to defer all capital gain taxes.
Still need more information? Consider this example:
- An investor has a $200,000 capital gain and incurs a tax liability of approximately $70,000 in combined taxes when the property is sold
- Depreciation recapture, federal and state capital gain taxes
- Only $130,000 remains to reinvest in another property
- 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
- If the same investor chose to use the 1031 tax-free 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-ratio ratios
As you can see from this example the 1031 tax-free exchange protects investors from capital gain taxes as well as facilitating significant portfolio growth and increased return on investment.
In order to access the full potential of these benefits, it is crucial to have a comprehensive knowledge of the exchange process and the IRC. 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.
Let Us Help You, Help Yourself!
Eastern Trust Real Estate Company has the resources to obtain accurate and thorough information about the entire exchange process. We would appreciate the opportunity to work with you on your next 1031 tax-free exchange regardless of how simple or complex! To get in touch with us about your 1031 tax-free exchange feel free to contact us or visit our website!