The Benefits of a 1031 Tax Exchange
In this recovering economy, real property can be a good investment. Whether your business is in real estate investing, or your business has nothing to do with real estate, but owns real estate that it operates from, as time goes by, the value of your property is likely to increase.
Taxes Can Hurt
And as the value of your investment or vacation property increases, you may want to sell it and upgrade (1031 exchanges aren’t typical for your primary residence, since special tax rules deal with the gain on primary residences). Whether you’re doing that for the purpose of purchasing more valuable property, or your business is simply growing and you need a bigger or better space, there are tax considerations that could hinder your ability to do either one.
This is because the increase in the value of your property is a capital gain. Put very simply, if you purchased property for $400,000, and sell it for $800,000, you have a $400,000 gain that you will pay or owe taxes on.
That means that when you go looking for bigger, better or more valuable property, you don’t have the full $800,000 to work with. You have that amount, less whatever the tax is on your profit. Not only does it decrease the money you have to purchase, but because you have less capital to put down, you may not be able to obtain a loan for as much as you need due to loan-to-value restrictions.
The 1031 Exchange
Luckily, the IRS has an exception for you if you’re in this situation. It’s called a 1031 exchange.
The 1031 exchange allows you to defer your tax burden on capital gains, so long as you’re using the money to buy another property for business or investment purposes.
Practically, this means that you won’t have to pay tax on the $400,000 profit in the near term. The amount gets rolled over into the new property. This way, with no immediate tax burden, you can use the full $800,000 you realized from the sale of your previous property towards purchasing new property.
You can even use the money from the sale not just towards the purchase of new property, but to improve it, or build a structure from scratch.
Requirements of the 1031
To get the benefit, you need to be purchasing what the IRS calls “like-kind” property, but that’s a broad term. You could sell a home you rent out for a multifamily unit. You could sell vacant land for developed property. As long as the new property is business related, it will usually be considered like kind property to the property you sold.
You will also need to incur about the same debt on your new property. So if you sold your property for $800,000, and paid an existing mortgage off of $300,000, you couldn’t invest the full $800,000 into an $800,000 property. You would need to buy property where you are incurring about the same debt the property that you sold had.
Make sure your business gets all the tax advantages it can. Contact Tampa business attorney David Toback to discuss protecting your business and its assets.