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It is becoming more and more common to hear individuals as well as real estate investors talking about the deadlines and requirements of 1031 tax exchanges. The term often appears in articles, on websites, on radio talk shows and in conversations in your accountant's waiting room. What you don't hear nearly as frequently are the reasons why someone would go to the trouble of meeting the guidelines for the exchange. Is it something that only the "big dollar" investors need to concern themselves with? Does a 1031 tax exchange offer benefits to an "average" investor like you, and if so, what benefits does it offer? Under Section 1031 of the Internal Revenue Code, some types of property exchanges allow you to defer capital gains you may have made on a property you are selling. Since the capital gain itself is being deferred, you are also deferring the payment of any taxes owed on the gain. Capital gains tax rates usually range between twenty and thirty percent of the amount of the gain. Since you didn't have to pay out taxes owed to the Internal Revenue Service for capital gains tax immediately, you have more money to reinvest in other properties you are purchasing. This can be especially important for smaller investors. If you have less money on hand to work with, you need to make sure you are using every dollar as wisely as you can. For example, you have a house that you paid $30,000 for at a foreclosure sale. You renovated it, and have it on the market for $95,000. You have a capital gain on this property of $65,000, and would normally owe capital gains taxes of approximately one quarter of that amount, or $16,250. You would then have $48,750 to reinvest. You are planning to buy a new house to renovate and resell, and are going to invest the proceeds from the sale directly into the new property. Instead, if you met the guidelines for a 1031 tax exchange, you could defer the capital gains tax and have the full $65,000 to invest in the new property. Now, this example does not account for the rehab money you used or expenses for financing if you did not pay cash. These factors would influence the amount of capital gains you make. However, this example does show you the basic concept. A 1031 tax exchange allows you to maximize the buying power of your money by keeping the cash in your hand long enough to reinvest it, instead of handing a chunk of it to the government at the time of your sale of property. Whether you are Donald Trump or an "Average Joe" investor, keeping your money working for you is critical!
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