A 1031 tax deferred exchange, as you know, allows you to use money from a real estate sale to acquire real estate of like kind. It also allows you delay the payment of the capital gains tax that would normally be levied on such a sale. A 1031 tax deferred exchange is a godsend for people looking to build their equity. This article details some of the things you need to know about 1031 tax deferred exchanges.

The Rules Governing a Totally Tax-Free Exchange

When you sell your property, a 1031 tax deferred exchange will allow you to acquire a property as replacement. To qualify for a totally tax-free exchange, the replacement property must be relatively equal to the value of the property that was sold. All of the equity you received from your initial sale should be used on acquiring your exchange properties. For instance, if you sold your original property for US$100,000, you must use up that same amount to acquire your replacement properties

The Rules Governing a Partial Tax-Deferred Exchange

A 1031 tax-deferred exchange does not necessarily mean that you have a totally tax-free exchange. Remember that you need to use all of the proceeds of your sale in acquiring the replacement properties to qualify for a 1031 tax-deferred exchange. Should you not do so, however, you may still qualify for a partial tax-deferred exchange. For instance, if you sold your original property for US$100,000, and you use only US$ 75,000 to acquire your replacement property, then you will be taxed on your US$ 25,000 gain.

The Disadvantages of a 1031 Tax-Deferred Exchange

As advantageous as 1031 tax deferred exchanges are, they nevertheless have a few disadvantages. One disadvantage is that you will be assessed a lower depreciation schedule when you acquire your new properties. The tax authorities will use your old taxes as a basis for this depreciation schedule. The other disadvantage is that you cannot deduct losses on your tax return if you use a 1031 tax deferred exchange. If you want to declare a loss, it will be better to make the transaction an outright sale, not an exchange.

You Don’t Have To Swap

You don’t have to swap one property for another immediately. In other words, when you sell your property, you don’t have to buy another right away. The law permits delayed exchanges. This means that that you can sell your property now, declare it 1031 tax deferred exchange, and then buy your desired property at another time.

You don’t necessarily have to swap the same number of properties either. For example, when you sell two tracts of land and place them in a1031 tax deferred exchange, it doesn’t mean that you have to get two pieces of property to qualify for the exchange. You can get one, three, or even ten properties in exchange for your two tracts of land! As long as the properties concerned are for investment purposes and are of relatively equal value, they will qualify. This means that you can diversify and expand your real estate properties without paying income taxes.