Benefits of a 1031 Exchange

Posted on: June 12, 2007

Most investors exchange properties through the IRS 1031 rule because they want to use the equity in a property to acquire a more desirable replacement property. Rather than selling and paying taxes (and depleting the amount of cash available for the reinvestment), the investor enters into a 1031 exchange. The exchange allows all sheltered gain to be transferred to a replacement without recognition of gain, which is payment of tax.

Although this is often called a tax free exchange, it is really a tax deferred exchange. The investor has sheltered the gain for the moment. In a future sale, Uncle Sam will claim his taxes on gain in the replacement property and the on sheltered gain from a prior sale. However, investors can take advantage of continuously exchanging property.

Exchanges can be used to defer taxes in a number of otherwise taxable transactions:

1. In a sale of property in which gain would be tax can be sheltered through an intermediary.
   
2. When an investor wants to move investment into another market, a tax free exchange allows a sale in one area and a purchase in another.
   
3. Sometimes a property will have no further use in its current form, and it needs to be developed. Farms in suburban areas and warehouses in retail areas are two common examples. An exchange allows the owner to sell to someone prepared to make better use of the property; and, the seller can invest the proceeds into another useful property.
   
4. Tax deferred exchanges can sometimes be used to produce improvements and otherwise develop property.