Debunking a Common 1031 Exchange Myth

A #1031 exchange can be an excellent way for an investor to rapidly build their real estate investment portfolio. By avoiding immediate capital gains taxes on the sale of investment or business real estate, an investor has more capital to reinvest – allowing them to purchase bigger and better properties.

But the ability to avoid immediate capital gains leads some to believe that section 1031 is a tax loophole. This is a more common myth than you might think, and one that should be immediately debunked.

A tax loophole is defined as “a provision in the laws governing taxation that allows people to reduce their taxes. The term has the connotation of an unintentional omission or obscurity in the law that allows the reduction of tax liability to a point below that intended by the framers of the law.” (Definition courtesy of www.dictionary.com)

However, the purpose of enactment of section 1031 of the tax code is to promote the continuity of investment. To ensure this continuity, the government allows for the non-recognition of capital gains taxes so long as the investor follows the rules, doesn’t receive any proceeds and reinvests in “like-kind” property. Should the investor fail to meet the stringent rules, then taxes will be immediately assessed.

And while the deferral of capital gains taxes may seem like a tax loophole to some, it is not. Why? Because only in rare circumstances will an investor who has deferred capital gains via section 1031 never pay those capital gains taxes. The investor usually does when they elect to finally sell investment property without reinvesting in something new.

In fact, at least one-third of all real estate-related exchanges do trigger some income tax to be paid during the exchange itself. And almost 90% of all exchanges do result in a future taxable disposition of the real estate.

If a 1031 exchange is in your future, visit our website to learn more about these powerful tax deferral tools and our qualified intermediary and replacement property locator services.