What is a 1031 Exchange and how can it benefit my property? A 1031 exchange is where you take the gain on the sale of your real estate asset and purchase a property of greater value to defer tax liability of capital gains.
In example:
If you purchase a commercial property for $1,200,000 and 10 years later it is worth $2,200,000 you have an appreciated equity gain of $1,000,000.
If you went to sell your property for that $2,200,000 you owe no tax on your original basis amount of $1,200,000, but you would be liable for capital gains tax on the $1,000,000 appreciated gain amount. At the current capital gains tax rate of 24% you would have taxes due of $240,000. So, you will only net $1,960,000 on the sale of the property after paying the tax.
However, there is another alternative to save you from having to pay capital gains on the gain of the asset appreciation using the 1031 exchange that was originally put in place by the United States Government in 1939.
Here is how it works in our example.
Instead of selling your property for $2,200,000 and getting paid cash, you declare that you are going to use the proceeds of the $2,200,000 to purchase another property of equal or greater value. The money is put in escrow and then you have around 180 days to buy the next property and if successful in the purchase, you don't have to pay the capital gains owed on your previous sale after securing the new property. Your basis will still be what it was previously at $1,200,000 and doesn't increase to the $2,200,000 of the new property price.
So effectively under the 1031 Exchange program the goverment is allowing you to trade your property for another and not charging you yet on the tax on the capital gains that you made on the first property. When and if you eventually sell your property off for cash, you will then at that time finally have to pay the capital gains tax on the appreciation of your basis at that time.
There are two main benefits of exchanging our property for a new one:
Gives you latitude to get rid of a property you don't want or like anymore for a new one that you see more promise in.
You can start the clock again at zero on the depreciation process of the new property which will help you offset more money on your annual income tax bill.
Hope this helps explain 1031 a little bit as it is a very complex process. If you decide to go this route on a property please consult your CPA or financial adviser first to find out all the fine details and minutiae - our article is only meant as a general overview.
We are looking for potential business partners!
We want to find business partners and qualified real estate investors who will come in on projects with us that mutually make sense where we can all come out ahead and make good money.
Feel free to email, text or call us with any questions about any of our media articles or any questions you have about being a potential business partner or investor with us.
Thanks,
Greg Arbutine
Alan Development Co-Owner
Invest in real estate with along side with us at Alan Development! We are the real estate experts that you can trust.
Awesome information!