Why Use a 1031 Exchange?

There are many things you can do with your real property – from keeping it to selling it to giving it away to family members or charity.

Each of these choices has predictable financial, legal, and other consequences, and wise real property transactions are made with a full awareness of, and appreciation for, all of these consequences – especially the tax consequences.

The sale of real estate is a taxable event, and all profit from the sale of real estate is taxed as capital gains in the year of the sale. If you sell a property that has appreciated in value, you will be required, in general, to pay capital gains taxes on the difference between what the property cost you and what you get for it now, plus recapture of any depreciation you have previously taken. If your property has substantially appreciated in market value, you will be required to pay a substantial amount of money as capital gains taxes and depreciation recapture to the government.

A Section 1031 exchange allows you to legally avoid paying these taxes.

Section 1031 (a)(1) of the Internal Revenue Code states that “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.”

What this section means is that Section 1031 exchanges – if done properly – have the special benefit, unlike other forms of real property transactions, of allowing the complete legal avoidance of capital gains taxes and recapture of depreciation.

Technically, a Section 1031 exchange is a tax deferral rather than a tax elimination technique. The new replacement property purchased with the proceeds from the sale of old relinquished property has the same tax basis as the old property, and when the new property is later sold, the deferred capital gain, plus any additional gain realized since the purchase of the new property, is subject to taxation.

But since you can continue to exchange the new properties you obtain through Section 1031 exchanges again and again, you can continue indefinitely to legally defer taxes.

In other words, by taking advantage of the full benefits of the Section 1031 exchange process, you never have to pay taxes on the transfer of real property. Upon death, the basis of property gets “stepped-up” to its fair market value and the accumulated capital gain is never taxed. Even those who inherit the property can sell it at its fair market value at the date of death and not pay tax on that gain.

As Section 1031 exchangers like to say, you can “swap ’till you drop.”

You don’t have to be a financial genius to recognize that avoiding tax liability is always a good investment practice. If you can defer payment of taxes to some indefinite date in the future, you will have more money to invest today.

By putting the money that you save in taxes today to work for you now in sound real estate investments, you will have more equity in the future. By properly using the tax avoidance strategy of Section 1031 exchanges, with the money you save by legally avoiding capital gains taxes and depreciation recapture, you are able to continually step up your real estate portfolio and build substantial wealth from your original investment.

To contact Melissa J. Fox about serving as a qualified intermediary or for other 1031 exchange services, send an email to strategicfox@gmail.com

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