Real Estate, 1031 Exchange - 1031 Tax Exchanges
The 1031 exchange process grew out of a need to solve a fairly common investment problem: how can an investor successfully manage and leverage taxes to the long-term benefit of his or her business? To understand the 1031 tax exchange process, you must first understand the history. Consider the following scenario: ten years ago, you purchased an investment property for $200,000. Today, that property is now worth $300,000. You're pleased with the growth in the property's value - and you'd like to further the success of your business by selling that property and investing the $300,000 in a different property that you believe represents a better opportunity for long-term growth. You've found a great property across town on the market for $300,000 that meets all your needs.
When you sell your current property, however, you won't walk away with $300,000 Why? In this very simple example, let's temporarily ignore closing costs and broker fees. On a very basic level, your property has brought you a capital gain of $100,000 over the past ten years. When you sell that property, you will have to pay capital gains tax on that $100,000. Assuming a 15% rate, then, you walk from your sale with $285,000 - which is not enough to purchase that property across town on the block for $300,000. Your tax obligation, then, has handicapped your purchasing power.
With a 1031 exchange, the IRS allots investors a mechanism by which they can immediately reinvest the proceeds from a real estate sale without paying capital gains taxes in the interim. 1031 tax exchanges allow you (the investor) to sell a property and leave the proceeds in the care of a qualified intermediary while you seek out a replacement and complete the purchase. The capital gains taxes you owe are not erased - but they are deferred during the time that you are actively involved in the real estate investment business. In the above situation, then, you WOULD be able to purchase that $300,000 property across town because you would not find yourself paying capital gains tax at the time of your initial sale. The 1031 exchange process, then, provides investors with a mechanism for maximizing buying and investing power in the real estate market today in exchange for delaying tax payments until tomorrow.
Related Tags: 1031 exchange, 1031 tax exchanges
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