Why You Should Know About 1031 Exchanges

Section #1031 of the US tax code is commonly referred to as the last available tax shelter for investment real estate. Within this important piece of tax law, there are provisions for “exchanging” business or investment property and deferring any capital gains taxes on the transaction.

When a 1031 exchange is completed, the seller preserves all capital appreciation by avoiding the tax liability of both state and federal capital gains and recaptured depreciation. The full amount of the seller’s capital appreciation can then be applied toward the acquisition of a new investment or business property.

With a 1031 exchange, a seller is often able to afford a more valuable investment property than had the investor followed the traditional sale and purchase route that incurs harsh tax liabilities. A 1031 exchange also allows investors to replace an underperforming property with something that will generate better return on investment, all while deferring capital gains tax.

You can easily see the power of a 1031 exchange in the following example. Both taxpayers sell a piece of investment real estate for $200,000. Both also have an adjusted basis of $100,000 and they each plan to acquire new investment real estate valued at $200,000 or more. Taxpayer 1 doesn’t take advantage of a 1031 Exchange, but Taxpayer 2 does.

Who would you rather be?

The really good news is that tenancy in common investments (where multiple investors share ownership of a common property) are eligible for 1031 exchange treatment. This means that an individual investor can save on capital gains and purchase even larger investment properties down the road.

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