Many real estate investors are surprised to learn that taxes do not disappear when completing a 1031 exchange. While a 1031 exchange can provide significant tax advantages, it’s important to understand how the tax rules actually work.
How Taxes Work in a 1031 Exchange
A 1031 exchange, named after Section 1031 of the Internal Revenue Code, allows investors to defer capital gains taxes when they sell an investment property and reinvest the proceeds into another qualifying like-kind property.
The key word here is defer. A 1031 exchange postpones taxes rather than eliminating them entirely.
When a property is exchanged, the tax basis and depreciation history from the relinquished property generally carry over to the replacement property. This means that depreciation taken on previous properties continues to follow the investment as it moves from one exchange to the next.
Understanding Depreciation Recapture
Over time, many investors claim depreciation deductions on their investment properties. These deductions reduce taxable income during the ownership period, which can provide valuable tax benefits. But when a property is sold, the IRS may require depreciation recapture, meaning the previously claimed depreciation deductions can become taxable.
If an investor performs multiple 1031 exchanges, the depreciation from each prior property typically continues to roll forward into the new property.
Deferral vs. Elimination of Taxes
A 1031 exchange is designed to delay taxes, not permanently eliminate them. By continuing to exchange properties, investors can defer capital gains taxes and depreciation recapture while keeping more capital invested in real estate. For many investors, this strategy allows them to grow and reposition their real estate portfolios over time while postponing tax obligations.
Defer Capital Gains Taxes, Compound Your Wealth
A 1031 exchange can be your ticket to capital gains tax deferral when selling investment or business real estate. This Internal Revenue Code section is commonly used by savvy investors to defer capital gains taxes and compound wealth. You can use section 1031 too! Contact a qualified intermediary at CPEC1031, LLC today to learn more about the like-kind exchange process and set yourself up for a successful exchange. You can reach us at our Twin Cities office, which is located in the heart of downtown Minneapolis. We’re here to help you defer taxes!
Start Your 1031 Exchange: If you have questions about 1031 exchanges, feel free to call me at 612-643-1031.
Defer the tax. Maximize your gain.
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