Advantages and Disadvantages of 1031 Exchanges

Many people have heard of the "1031 Exchange," but have no idea whether this applies to their own situation.  One common misconception is that you must actually have another property owner who is willing to "exchange" or trade their property for yours.  Instead, the term exchange means only that the property being sold is being replaced with "like kind" property. When dealing with real estate, like kind generally refers to most real property that is held for business or investment purposes. Like kind, however, does not include personal residences.

The main advantage of a 1031 exchange is that the process allows the gains from the transaction to escape current federal taxation, or in other words, the taxation is deferred. Another advatage is the ability to structure the transaction according to the needs of the parties. For example, if a party cannot locate a property  that is immediately available for purchase in an exchange, they can engage the services of an intermediary. This intermediary will temporarily hold the "exchange funds" in a qualified escrow account, so that the tax benefits of the exchange are preserved. The taxpayer will then have 45 days to designate an exchange property, and 180 days to close on the exchange property.

The disadvantage of a 1031 exchange is that the replacement property will have a reduced basis. This reduced basis will affect the depreciation allowed on the new property, as well as result in a deferred gain that will be taxed in the future if the property is sold outright.

Overall, 1031 exchanges are one of the most powerful tax deferral strategies remaining in the Tax Code. A taxpayer who intends to reinvest the proceeds of a business or investment property in similar property should most certainly investigate this option prior to the sale of purchase of additional property.

For more information regading 1031 Exchanges, please contact

 Carol Smith at (602)315-8859 or email

carolsmithrealtor@cox.net