Thanks to Section 1031 of the Tax Code, a properly structured like-kind exchange allows an investor to sell a property in certain situations, reinvest the proceeds in a different property, and defer capital gain taxes. The four basic steps in a 1031 exchange are:
- The seller arranges for sale of property and includes exchange language in the contract.
- At closing, proceeds from the sale go to a qualified intermediary for a 1031 exchange.
- The seller identifies potential exchange properties within 45 days of closing.
- The seller completes the 1031 exchange within 180 days of closing.
Here’s how it works: Let’s say you have a $200,000 capital gain and incur a tax liability of approximately $50,000 in combined taxes (depreciation recapture, federal and state capital gains taxes) when the property is sold. Only $150,000 remains to reinvest in another property.
Assuming a 25 percent down payment and a 75 percent loan-to-value ratio, you would only be able to purchase a $600,000 different property. However, with a 1031 exchange, you’d be able to reinvest the entire $200,000 of equity in the purchase of $800,000 in real estate, assuming the same down payment and loan-to value ratios exist.
Contact Yeo & Yeo to learn how a 1031 tax-deferred exchange can help increase your return on real estate investments.