All About Exchanges

Why do an Exchange - More Reasons than Tax Savings Completing a 1031 Exchange enables the investor to defer paying capital gains taxes (All About Exchanges, Item 2-1) on investment properties that are being sold. If an investor wanted to take cash out of the sale of a property, he could not do so without paying taxes. If, however, the investor exchanges into a property with an equal or greater amount of equity and debt as was on the sold property, capital gains taxes are deferred. Many real estate investors find that once a property has significantly depreciated, there is no longer any income tax benefit to holding that property. Therefore, the investor will exchange into a higher priced property to both defer capital gains taxes and offset income tax liability with additional depreciation. 1031 Exchanges are also a vehicle used by real estate investors to defer income taxes on the profits realized from their investments. More importantly, if one sells a property and decides to take the profits and pay the taxes, not only is the amount of taxes paid forfeited, but the earning power of the profit and the taxes paid is also lost. For example: Capital Gain Amount (profit) $1,000,000 Capital Gain Tax (20%) $200,000 *State Tax (10%) $100,000 Total Taxes Paid $300,000 * - State taxes vary from state to state If this $300,000 were re-invested in real estate through a 1031 Exchange, at 9% return, in 10 years, the $300,000 would grow to be $710,000. And this does not take into consideration the tax savings over the 10 year period as a result of the depreciation on the real estate. Why would anyone ever pay Capital Gains Tax? In addition, 1031 Exchanges can be used as an estate planning deice. Investors can do exchange after exchange to create a pyramiding effect and the tax liability is forgiven upon the death of the investor as the heirs get a stepped up basis on the inherited property.