1031 Exchange - 1031 Tax Exchanges

If you’re involved in the real estate investment business, you know that being savvy about how you manage your sales and purchases can make a huge difference in the success of your business. Smart real estate investors, then, know that a well-planned and well-executed 1031 exchange is one of the best ways to preserve and accumulate real estate wealth. The IRS specifically designed 1031 tax exchanges to allow people who own real estate for investment or business purposes to effectively maximize the growth of their business’s worth over time: 1031 tax exchanges provide investors with an incredible tool for wealth management and development.

The 1031 exchange process grew out of a need to solve a fairly common investment problem: how can an investor successfully manage and leverage taxes to the long-term benefit of his or her business? To understand the 1031 tax exchange process, you must first understand the history. Consider the following scenario: ten years ago, you purchased an investment property for $200,000. Today, that property is now worth $300,000. You’re pleased with the growth in the property’s value – and you’d like to further the success of your business by selling that property and investing the $300,000 in a different property that you believe represents a better opportunity for long-term growth. You’ve found a great property across town on the market for $300,000 that meets all your needs.

When you sell your current property, however, you won’t walk away with $300,000 Why? In this very simple example, let’s temporarily ignore closing costs and broker fees. On a very basic level, your property has brought you a capital gain of $100,000 over the past ten years. When you sell that property, you will have to pay capital gains tax on that $100,000. Assuming a 15% rate, then, you walk from your sale with $285,000 – which is not enough to purchase that property across town on the block for $300,000. Your tax obligation, then, has handicapped your purchasing power.

With a 1031 exchange, the IRS allots investors a mechanism by which they can immediately reinvest the proceeds from a real estate sale without paying capital gains taxes in the interim. 1031 tax exchanges allow you (the investor) to sell a property and leave the proceeds in the care of a qualified intermediary while you seek out a replacement and complete the purchase. The capital gains taxes you owe are not erased – but they are deferred during the time that you are actively involved in the real estate investment business. In the above situation, then, you WOULD be able to purchase that $300,000 property across town because you would not find yourself paying capital gains tax at the time of your initial sale. The 1031 exchange process, then, provides investors with a mechanism for maximizing buying and investing power in the real estate market today in exchange for delaying tax payments until tomorrow.