The Benefits of a 1031 Exchange

Tax Professionals' Resource
September 20, 2012 — 1,194 views  
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Investors hoping to avoid taxes related to the sale of investment property may be interested in completing a 1031 exchange if a comparable property would be beneficial to the investor's portfolio. 

What is a 1031 exchange?

A 1031 exchange is a tax deferral strategy that many investors use as a way to keep more cash free in the present for investing purposes. The exchange involves the sale of one property and the purchase of another property. The properties in question must be qualified to be used in a 1031 exchange, and a specific process must be followed in order for the transaction to be considered as an exchange rather than a sale and purchase.

It is important that the property that is being purchased after the sale of the initial property be acquired for at least as much as the original property. Any proceeds of the sale of the initial property must be used in the purchase of the second property in order for the process to be considered a 1031 exchange.

When is a 1031 exchange necessary?

A 1031 exchange may not be strictly necessary for investment purposes, but the tax benefits associated with the exchange are often necessary for investors to maintain a solid return on investment.

Individuals should note that a 1031 exchange may only be used for property that is held for investment or business purposes. The exchange is not intended to be used by a homeowner to exchange one house for another, and the IRS will not allow an individual to receive any of the benefits of a 1031 exchange if a homeowner attempts to use an exchange for personal purposes.

What are the benefits of 1031 exchanges?

A 1031 exchange gives an investor the opportunity to diversify their portfolio by acquiring property in many different locations. Tax benefits related to a 1031 exchange include the possibility of deferring taxes due, the exchange of a property that is not eligible for depreciation for one that is able to be depreciated and the possibility of continually deferring taxes for estate planning purposes.

Investors may want to get rid of one property that is not adequately providing a return. While a sale without an associated purchase that could be considered an exchange will result in tax liability, investors could potentially avoid tax liability completely by utilizing a 1031 exchange and acquiring a lucrative property.

Tax Professionals' Resource