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Things investors need to know about investing in real estate: the 1031 exchange

Things investors need to know about investing in real estate: the 1031 exchange

For those interested in investing in real estate in Miami or in the United States, it’s important to be aware of the fiscal opportunities that the IRS gives them.

Thanks to IRC Section 1031, a properly structured 1031 exchange allows an investor to sell a property, to reinvest the profits in a new property and to defer all capital gain taxes. IRC Section 1031 (a)(1) states:

"No gain or loss shall be recognized on the exchange of property held for productive use in a trade or business or for investment, if such property is exchanged solely for property of like-kind which is to be held either for productive use in a trade or business or for investment."

The investor that decides to take advantage of this powerful tool, has 45 days to identify another property with the same value or greater and up to six months to complete the closing. Pre-constructions need careful attention if selected for this exchange.

To better understand the protection the 1031 exchange can offer, an investor should consider the following example:

  If an investor has a $200,000 capital gain, he/she would typically incur in a tax liability of about $70,000 in combined taxes (depreciation recapture, federal and state capital gain taxes) at the time the property is sold. In this case, only $130,000 would remain to be reinvested in another property.


  Assuming a scenario with 25% down payment and a 75% loan-to-value ratio, the seller would only be able to purchase a $520,000 new property.
 

  If the same investor chose to exchange, though, he/she would be able to reinvest the whole $200,000 of equity in the purchase of $800,000 in real estate, given the same down payment and loan-to-value ratios.

As the previous example shows, exchanges protect investors from capital gain taxes as well as facilitating the growth of one’s portfolio and the increase of the return on investment. A great number of luxury properties have been purchased thanks to 1031 exchange all over Miami and Miami Beach.

In order to access the full potential of these advantages, it is of paramount importance to have a clear knowledge of the exchange process and the IRC. For example, a precise understanding of the  term like-kind - often mistakenly thought to mean the same exact types of property - can uncover possibilities that might have been dismissed or overlooked.

For this reason, it’s always advisable to ask for assistance from a professional in the field of law or accounting, to fully take advantage of the possibilities provided by 1031 exchange.

 

 

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