Thanks to IRC §1031, a properly structured 1031 exchange allows an investor to sell a property, to reinvest the proceeds in a new property and to defer all capital gain taxes. IRC §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.”
To understand the powerful protection a 1031 exchange offers, consider the following example:
- An investor has a $200,000 capital gain and incurs a tax liability of approximately $70,000 in combined taxes (depreciation recapture, federal and state capital gain taxes) when the property is sold. 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 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-to-value ratios.
As the above example demonstrates, exchanges protect 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. Global Realty Group and our strategic Qualified Intermediary partners are your resource to obtain accurate and thorough information about the entire exchange process.
Guideline Summary for IRC §1031 Exchange Transaction:
ID Period: The replacement property must be identified within 45 days from the sale of the original property.
Exchange Period: The replacement property must be acquired (closed) within 180 days from the sale of the original property.
Property Type: The replacement property must be “like-kind” and for investment purposes.
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