If you own rental properties or other real estate as an investment and do not have a solid understanding of the benefits of a 1031 Exchange, you should get one. Fast. Unless you like watching your money spiral down the drain. If that’s the case, don’t worry about it.
Simply put, a 1031 Exchange is a method for selling your current investment property and then re-investing the proceeds from that sale into another investment property within a certain time frame. The IRS treats this as an exchange and not a sale, therefore allowing the investor to defer paying taxes on accrued profits until they are actually taken as income at some point in the future.
Here’s a quick example using numbers only for example. Let’s say our purchase price is $100,000 in 2000 and we sell for $200,000 in 2010 and we want to take our money, move up and re-invest in another rental property. If we treat the transaction as a sale, the IRS sees this as a taxable event. Therefore, we now owe a minimum of $20,000 to Uncle Sam and have $180,000 to re-invest. (15% fed rate and ~5% CO rate. Depending on your income bracket these numbers can be different) If we do a 1031 exchange however, we are able to re-invest the entire $200,000 into the next property we buy.
I’m by no means a 1031 expert and there are a lot of specific things to take into account, but the above example should give you an idea of the concept.