Understanding the 1031 Tax-Deferred Exchange

If you own an investment property and want to sell, you need to become at least familiar with the 1031 exchange. While the concept of how a 1031 works is fairly straight forward there are many different details that can become involved. It is highly advisable to use a 1031 tax exchange professional to avoid any mistakes that could cost you big bucks.

I will use simple numbers so that it is easier to understand. First of all 1031 exchanges have no impact on selling your personal real estate; it is solely to be used for personal property or real estate that is intended to produce income. Again, there are many different provisions that apply, so use a professional. So you buy an apartment house for $125,000, you put $20,000 down and get a $105,000 mortgage. Tenants have paid the mortgage through the years that you have owned the property and have the mortgage paid down to $75,000. Property values in your area have done well (I know I know it is for the example) and your property is now worth $175,000, that gives you $100,000 in equity to work with. You find a $300,000 rental unit that you would like to own so you sell your original unit for the $175,000, pay off your original remaining loan ($75,000) and use the $100,000 remaining as a down for the $300,000 and take a $200,000 mortgage on the new property. You have transferred the equity from one property the other, had you sold the property outright you would have had to pay cap gain on the difference on the depreciated value and what you sold it for. Cap gain tax currently starts at 15% and has been as high as 35%, so you can see that your tax savings can be substantial.

1031's are not something you want to attempt yourself, there are strict rules regarding the disbursement of funds etc, do it wrong and you are going to pay the tax, the IRS doesn't care what your intentions were. I am going to say it again, use a 1031 tax facilitator to complete your transaction. It doesn't hurt to have an agent who is familiar with the process as well.

If you have any questions or I can be of help in your real estate world, feel free to contact me.