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The 1031 Tax Exchange Explained
The 1031 tax exchange is part of the IRS code that allows owners to sell said properties without incurring capital gains expenses. Basically, it lets property owners defer their taxable gains on the sale of a property by purchasing a similar one.
By: Coldwell Banker Schmitt Real Estate
The 1031 tax exchange is a provision of the Internal Revenue Service, which gives property owners the option to defer their tax obligation when selling a piece of real property. It is calculated on a simple formula, which consists of the property's present value, and what it was worth when first purchased.
A simple example would be purchasing a residential house as a rental property for $200,000. About 5 years later, that property has appreciated considerably and is now worth $300,000. So, the gain on this property would be $100,000, and that would be considered a profit to be taxed at the current capital gains rate. If that rate of the capital gains tax is at 15%, that means the investor would have to pay $15,000 to the IRS after selling the house.
However, this tax burden can be deferred by taking advantage of the 1031 exchange rule in the tax code. In order to do so, the property owner can sell one property and buy a similar piece of real estate, thus allowing the money from the sale of the transaction to pass into the purchase of another. Of course, there are stipulations that must be met in order to benefit from the 1031 tax rule. The property that is purchased after the sale of another must be similar in nature. In other words, it's not possible to buy a residential home, refurbish it, rent it out for a number of years, then sell it, and buy a piece of commercial retail property under the 1031 tax rule. Instead, the property owner of the residential rental would have to purchase another residential house that is similar in order for it to comply with the 1031 tax exchange rules.
In order to take advantage of the 1031 tax exchange, property owners should speak with an experienced and licensed tax professional in order to understand all of the implications and restrictions governing this option.
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