1031 Exchange - A Taxpayers Secret Weapon to Paying Less - Part I of IV

Are you thinking about changing up your real estate investments - looking for properties with better opportunity for appreciation or increased rental income potential, but you're worried about capital gains tax on the profits? Welcome to the world of the 1031 Exchange.

The Internal Revenue Code (IRC) 1031 Tax Deferred Exchange is a great way to sell your investment property and trade up to another investment property, tax deferred. And by investment property, we mean any property that’s not your principal residence or second home. Typically, it’s a rental that’s either residential, such as a house, townhome or condo, or commercial, like an office building, warehouse or strip mall or vacant land that’s either residential or commercial.

The benefit of a 1031 exchange is the postponement the tax payments on the gains from the sale of your investment property. It’s tax deferred, not tax-free, and you need to reinvest the proceeds into another like-kind investment. It doesn’t have to be the same type of property, nor does it have to be one for one. You can exchange a few properties for one (or vice versa) or exchange residential for commercial (or vice versa), but you can’t exchange an investment property into a new principal residence for yourself. Eventually, when the investment property is ultimately sold (not part of another exchange), the original deferred gain, plus any additional gain realized since the purchase of the replacement property is subject to tax. 

Another exchange example is a construction exchange for exchanging property into vacant land and building a home, but we’ll touch on that topic in another blog.

Here’s a great story about a client of mine who inherited investment property. Their family bought the property for around $40,000 back in the 1940s, over time it had deteriorated and was in need of some TLC. However, the property was now worth a whopping $1,150,000! After all the repairs and money that went back into the property, there was a gain of over $1,000,000. This was not their principal residence so they would owe capital gains tax – in the end they’d be left with around $700,000 to enjoy or invest.

They decided to execute a 1031 Exchange and invest in a new house for $1,200,000. Instead of paying $300,000 to the IRS, they rolled that money into their new investment property, tax deferred.

I hope this gives you a brief introduction into the world of the 1031 Exchange. In the next part of this four-part series, we’ll go deeper into the intricacies of a 1031 Exchange. 

This information is for general informational purposes and doesn’t constitute legal, accounting, tax or other professional advice or services. If you have questions concerning your tax liability or to determine whether you should realistically expect to be impacted by this new tax, please connect with your tax professional.

Please feel free to contact me with any real estate questions that you may have. I’m here to help others make real estate happen.

Warmest Mahalo,
Kengo Ueno (R)

Kengo Ueno (R)

 
eCertified, ABR

Direct: (808) 739-4148
Mobile: (808) 222-4447
Fax: (808) 732-8448
email: kengo.ueno@pruhawaii.com

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