“The term 1031 Exchange is defined under section 1031 of the IRS Code. (1) To put it simply, this strategy allows an investor to “defer” paying capital gains taxes on an investment property when it is sold, as long another “like-kind property” is purchased (within a certain time frame) with the profit gained by the sale of the first property.”
When you start making a lot of money on your investments by cashing out you will want to consider deferring these profits into the future.
Basically, by identifying a “like kind” property and using a fudiciary to escrow funds you are able to sell one property and reinvest the funds into the other property thereby realizing no profit. No profit in this scenario means no capitol gains taxes.
Theoretically, you can continue rolling your profits into future deals indefinitely thereby never having to pay the taxes. You will want to read the link above on “how too…..” and consult your accountant or attorney. Once you choose a fiduciary to work with you they will walk you through the steps.
There are some expenses involved in this and the math doesn’t work usually unless your making a good amount of money. Your tax bracket will also contribute to any value you may gain. That said it can be one of the most beneficial strategy’s in acquiring wealth.
I once bought a lake property foreclosure for 165,000 from my bank which was located in Eagle, Wisconsin on Eagle Lake. I rented the property for $1,400 per month which took a few months since it wasn’t in a good area for renters. After 2 years the tenants wanted to buy the property and offered me 200,000 for it.
After costs I’m looking at making 30,000 not counting my rental income to date which translates into 9000 in taxes at the 30 percent tax bracket. I could have paid the taxes and moved ahead with my $21,000 check. Instead I spent about $1,000 to structure a 1031 exchange. This enabled me to roll the entire 30,000 into a 12 unit building that was producing $4,320.00 monthly. The 30,000 basically ended up being my down payment.
Part of what made this work is that I didn’t need the $30,000 to spend elsewhere, if I did there is a way that part of the money could have been pulled out which is a whole different post.
This is a brief generalization of the concept, as with many of these concepts, it’s not required for you to understand its entirety until you find yourself in this situation.
Just keep in mind that if you are going to make a bundle on a deal you will need to do some research to see about deferring these taxes.