Section 1031 Exchange – Overview
Investors can defer taxes that would have been payable on capital gains at a later date by utilizing a Section 1031 Exchange.
Effectively this means that a property investor who trades an investment property for one or more similar properties for investment use can then defer the payment of income taxes to the federal government and even defer some state taxes.
This is effective for any asset classified as ‘real property’ as long as it’s used for investment purposes, active use in a trade or business or for the production of income.
The logical basis behind the IRS allowing investors to use the Section 1031 Exchange is that the investor has sold a property and then reinvested the sale proceeds back into a buying a new property. The investor never actually received the sale proceeds in a form that gives the person any funds so the IRS doesn’t classify the capital gains as being taxable income.
Section 1031 Exchange put simply means that as long as the taxpayer exchange an investment property for another property or properties or the same type, then the IRS consider the person has not received anything that could be used to pay taxes with.
The capital gain was transferred from one asset to another, so that the IRS does not recognize any gain or loss as part of your taxable income.
Please do not make the mistake of judgment that the Exchange 1031 means the same thing as “tax free”. The fact remains that the tax that you paid is deferred until you finally sell the property you have purchased as replacement for the first investment you sold.
At the point in the future where you do sell the replacement property then you should be aware that you will be taxed on the original capital gain that you deferred plus you’ll also be taxed on the additional gain you may have realized since you first bought that property as well.
Obviously, if you come to a decision not to sell, then you can actually continue to defer taxes that would have been payable on the capital gain as long as you keep the property.
The exchanges of shares in the different actions are not eligible. This means that if you sell a stock you need to exchange for more of the same stock to take advantage of Section 1031 Exchange and defer tax on any capital gain you have made.
No comments yet.
Leave a comment
