Imagine saving thousands of dollars on your next commercial real estate transaction. Section 1031 of the U.S. Internal Revenue Code allows for the exchange of one investment property for another, providing the opportunity to defer the capital gains tax on approved property transactions.
A 1031 exchange is a method for selling one qualified property, then purchasing another qualified property within 180 days of the initial transaction.
The process works much like any other commercial real estate selling and buying situation. Because investors are exchanging properties, the IRS allows those investors to defer the capital gains tax on the initial sale.
There are two points that need to be closely adhered to in order to qualify for a 1031 exchange.
First, the total purchase price of the new investment property must be equal to or greater than the property that was sold or being sold. Second, all the equity received from the initial sale must be used to purchase the replacement property. If there is any shortfall in the purchase price of the similar property, the investor will be liable for any capital gains taxes associated with the sale.
It can also be used as an investment strategy by realizing the effects of compounding the savings in capital gains and reinvesting it in your new property purchase. The key to getting the best compounding result is to keep all of the money, including the value of the deferred tax, working for the investor. By reinvesting you will maximize the compound yield of your investment at a future time.
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