1031 exchange
By Preston Ames
What is a 1031 like kind exchange?
A 1031 exchange is known for its name by investors because it is the section 1031 in the tax code. This section allows tax deferred treatment of gains on a property when two properties are exchanged. In real estate it is common for investors to exchange properties to change their position in the market. The exchange allows an investor to keep all the proceeds of the sale with no tax and put that into a new like property. This allows quicker growth and cheaper money to go into an investment.
The old property fair market value plus cash added has to equal the new property fair market value and this allows it to qualify as a 1031 exchange.
How is a 1031 exchange taxed?
The investment is tax deferred growth on capital gains. After a year they get taxed at long term capital gains rate.
How does depreciation and recapture work?
Let’s say Kevin purchased a rental property for $300,000 and takes $80,000 in depreciation then the new adjusted basis is $260,000.00.
Let’s say that Kevin’s building has a fair market value of $450,000.00 less adjusted basis of $260,000.00 = gain of $190,000.00
What is boot?
Boot is cash traded in a transaction for real property.
Kevin swapped a property for a new property of $600,000 . The old property had a fair market value of $450,000 so he adds 150,000 of cash boot. The old basis was $260,000 and now the new basis is $410,000.
How does recaptured depreciation work?
The deprecation gets added to the rental property and allows the rental to operate in a cost effective way. Depreciation allows the investor to recognize losses and this reduces gains. This gets to reduce the taxable gains.
A drawback is that when you sell the property the deprecation taken out of that time gets added back into the sale. This will reduce the basis but increase the capital gains. 1031 can be used as an estate tool because the depreciation gets stepped up at the owners death and never gets recaptured.
How is boot taxed?
Recognized boot is taxed as taxable income in an investment.
*Read section 1031 in irs tax code for further reading.