Tyson Properties, Inc.
1031 Real Estate Exchange
Internal Revenue Code Section 1031, known as IRC § 1031, allows a properly structured 1031 exchange to be sued by an investor to sell a real estate property and reinvest the sale proceeds in a new property purchase while deferring the capital gains tax. Section 1031 states:
"No gain or loss shall be recognized on the exchange of property held for productive use in a trade or business or for investment, if such property is exchanged solely for property of like-kind which is to be held either for productive use in a trade or business or for investment." IRC 1031 (a)(1)
The following example illustrates the protection a properly structured 1031 exchange can provide:
- A $200,000 capital gain exists and the investor incurs $70,000 in combined tax liability (federal and state capital gain taxes, depreciation recapture) once the property sells. The amount remaining to invest in a new property is $130,000.
- The seller is only able to purchase a new property at $520,000, assuming there is a down payment of 25% and a loan-to-value ratio of 75%.
- However, if this investor chose instead to exchange, she would be able to reinvest the full equity of $250,000 to purchase $800,000 in real estate if the same down payment and percentage of loan-to-value ratios were used.
The above example shows exchanges protector the investor the capital gains tax and assist the investor in building portfolio growth and ROI.
To take advantage of the full potential of the benefits of a 1031 exchange, the investor must gain a comprehensive understanding of the IRC and the exchange procedure.
Start with the IRS’s webpage titled “Like-Kind Exchanges Under IRC Code Section 1031“. There you will find information about who qualifies for the exchange, what structures are used and what types of properties are accepted. Section 1031 cannot be used for exchanges of Inventory or stock in trade; stocks, bonds, or notes; other securities or debt; partnership interests or certificates of trust.