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The Benefits of an IRS 1031 Tax Deferred Exchange

By Edited Nov 13, 2013 0 0


One of the best kept secrets to investing in real estate is the IRS 1031 Tax Deferred Exchange, which allows you to sell your investment property and exchange for a like-kind property without having to pay any taxes on your gains.

The Definition of 'Section 1031'

According to Investopedia, the 1031 is a section of the U.S. Internal Revenue Service Code that allows investors to "defer capital gains taxes on any exchange of like-kind properties for business or investment purposes. Taxes on capital gains are not charged on the sale of a property if the money is being used to purchase another property - the payment of tax is deferred until property is sold with no re-investment."

Why This is Awesome and Can Make You Rich
Say you bought an investment property in 1990 for $100,000. You do a lot of work on that property and it appreciates in value over the years to $300,000, and let's say it cash flows at $30,000 a year. Not bad. So you are now sitting on a property that has appreciated in value $200,000 - that is your capital gain. You want to sell the property now. You would have to pay taxes on that $200,000 - let's say 20 percent or $40,000. But wait a second - you can use the 1031 tax-deferred exchange instead.
So now you find a property on the market for $1 million dollars that cash flows at $80,000 a year. You can't afford this, can you? You should be able to. With the $200,000 in gains, you can put it as a down payment on the $1 million dollar property, a 20 percent down payment. So your income went from just $30,000 a year to $80,000 a year, and you avoided paying taxes at all on the sale of your first property.

Here are two general rules you must follow, according to 1031 Exchange Made Simple:

1.  The total purchase price of the replacement "like kind" property must be equal to, or greater than the total net sales price of the relinquished, real estate, property.

2.  All the equity received from the sale, of the relinquished real estate property, must be used to acquire the replacement, "like kind" property.

Who Has Used it?

Many millionaire real estate investors  out there today have taken advantage of this great tax-saving strategy, including best-selling author Robert Kiyosaki of "Rich Dad, Poor Dad."

Or how about Gary Gorman of "the 1031 Exchange Experts?" Gary is an author and 1031 expert who has written extensively on the IRS exchange. He is the acclaimed author of the book "Exchanging Up!" According to his website, his articles have been published nationwide and he has been quoted in a number of publications like the New York Times. Other books to check out on the 1031 exchange are "The 1031 Tax Advantage for Real Estate Investors" by Timothy Harris, "1031 Exchanges Made Simple" by Michael P. Owens and finally "The Tax-Free Exchange Loophole: How Real Estate Investors Can Profit from the 1031 Exchange" by Jack Cummins. You can buy all books on the 1031 exchange here.


Make sure you use a 1031 specialist or a qualified intermediary when conducting a 1031. According to Wikipedia:  "A QI should be bonded and insured against errors and omissions. Relevant educational background such as tax, law or finance is desired. Nevada is the only state that requires a QI to be licensed.

The QI enters into a written agreement with the taxpayer where QI transfers the relinquished property to the buyer, and transfers the replacement property to the taxpayer pursuant to the exchange agreement. The QI holds the proceeds from the sale of the relinquished property in a MAIC trust or escrow account beyond the actual or constructive control of the Exchangor. The QI also prepares the necessary documents to accomplish a tax deferred exchange."

Best of luck investing in real estate. If this is all new to you I recommend checking out my top 5 favorite books on money and real estate. I hope you now understand the benefits of an IRS 1031 Tax Deferred Exchange!



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