Are you interested in selling a piece of real estate, but you are worried about having to pay a substantial capital gains tax? After meeting with one of our financial advisors, you should come away with a much better understanding of when to consider a 1031 exchange that allows you to exchange a real estate property for another real estate property without having to pay capital gains taxes on the exchange. However, you should consider a 1031 exchange only when holding a piece of real estate makes the most financial sense before you consider the implications of capital gains taxes.
Overview of a 1031 Exchange
Authorized under Section 1031 of the Internal Revenue Code, a 1031 exchange permits a seller of a property to avoid paying capital gains taxes. Although you have to consider several factors when considering a 1031 exchange, answering two important questions can help guide you towards making the best decision to match your financial goals.
First, you must determine whether you face paying capital gains taxes after selling a property. Second, should you buy a replacement property? If you answer yes to both questions, then using a 1031 exchange represents an effective strategy for deferring taxes.
The primary reason for completing a 1031 exchange is to defer paying capital gains taxes when selling a property, whether the property is a business or simply an investment in real estate. A 1031 exchange allows you to roll over your investment in the first property into an investment in a replacement property. Because you do not liquidate the first property by selling it, a 1031 exchange provides you with an effective tool to avoid paying capital gains taxes.
How to Answer the Two Questions
For any property owner that considers a 1031 exchange, answering question one requires you to calculate the amount of tax you must pay when selling the property in question. If the sale of the property results in a profit that requires you to pay a capital gains tax, a 1031 exchange helps you defer payment on the capital gains tax. You determine the profit by subtracting the basis value of the property from the sale price of the property.
Answering question number two concerns your goals as a real estate investor. This is the question that does not take into account fiscal issues, but instead, determines whether rolling over one property for another property matches your real estate investment strategy. If you are interested in continuing with owning real estate, then a 1031 exchange is the ideal financial strategy.
Question number two is the most important question to answer because it lets you know if you want to invest in another property without considering the tax benefits. When you meet with one of our financial advisors, discussing the pros and cons of a 1031 exchange is one of the many services that we provide.