Back in the day I used to teach after tax cash flow analysis to house…
In last week’s article, we explored the anatomy of a 1031 exchange and the government’s reasoning for creating such a powerful tax-saving tool. This week, we’ll look at a hypothetical example such that we may more clearly understand how a 1031 exchange works. We’ll close by addressing some common concerns. Let’s get to it!
Ted’s First Investment Property
Ted understands the advantages or real estate investing and does everything he can to acquire his first investment: a nice little income property located at 101 Main Street. After careful analysis, he purchases it for $400,000 and pays $8,000 in acquisition costs. Over the next year, he operates the property as a rental—this is crucial because simply acquiring property for the sole purpose of resale does not qualify for a 1031 exchange. During this time, Ted replaces the roof and makes some other capital improvements totaling $15,000. He also takes a depreciation tax deduction of $5,333.
Most real estate investors understand the general concept of a 1031 exchange or, at the very least, have heard of it. Few, however, understand exactly what takes place within one of these exchanges and how powerful a tool it truly is. So let’s explore a subject that is close to everyone’s heart: not paying taxes on hard-earned money!
What’s in it for Uncle Sam?
So, why does the IRS Section 1031 like-kind tax-deferred exchange exist in the first place? After all, doesn’t the government relish every taxable opportunity? While the government is certainly not adverse to taxation, they also use the tax code as a tool, encouraging or discouraging certain acts they deem beneficial or detrimental to the economy. As it turns out, the private sector is pretty darn good at providing housing to society (a lot better than the government). As such, Uncle Sam provides various benefits to real property owners (mortgage interest deductions, real estate investment expense deductions, ability to depreciate, etc.).
The mortgage interest deduction, which has long been an untouchable pillar of the tax code…
Cost segregation is a tax saving method that apparently has caught on with the opportunity…