Explaining Capital Gains and Tax Deferment

Written by admin on January 27th, 2012

Article by Damien Christian

Explaining Capital Gains and Tax Deferment

By Damien Christian

Death and taxes; while both are certain, the sting of capital gains tax can be significantly softened for real estate investors. Although the tax man likes to keep his fingers in the pockets of the American public, we do find precious instances where the IRS cuts us some slack. Most of us have or know something about tax-deferred retirement vehicles such as IRAs and 401Ks. Simply stated, the government won’t tax these savings as long as we do not touch the investment. We can even move capital around without penalty if the money is transferred or rolled-over within a specified period of time. A real estate investor, like a retirement planner, can also enjoy a tax-deferred, “roll-over” benefit of sorts. This lesser known real estate perk is a 1031 exchange.

A 1031 tax-deferred exchange is a real estate transaction where the proceeds of a building or property sale are reinvested into a like-kind asset, i.e. another building or property. Similar to a 401K roll-over, the reinvested funds of a 1031 tax exchange are tax-deferred, and there is no recognized capital gain or loss. Bear in mind that in order to qualify, the replacement like-kind asset must be purchased within 180 days of the sale. Since 1031 exchange properties must be business or investment properties and not personal residences, the benefit is reaped by the businessmen, the landlords, and the entrepreneurs. That’s all the more incentive for the rest of the population to jump in the game.

But how do 1031 tax-deferred exchanges play out in the everyday? Let’s say, for example, that an investor purchased an apartment complex in South Boston during the mid-nineties. The property she bought for $ 500,000 sells for $ 1,000,000 less than ten years later. A $ 500,000 appreciation is certainly nothing to scoff at. But what about capital gains tax? If the proceeds of the sale are reinvested into another building (within the 180 day closing period), the investor can potentially avoid a painful tax hit. During a qualified 1031 exchange, capital gains are not taxed.

If you want to complete a 1031 exchange, but don’ want to into a property that will require time and effort to manage, you can also invest in a portion of a professionally managed, commercial grade property along with other investors. This is called a “tenant in common” arrangement. Tenant in common allows you to hold an undivided title of a property and satisfies the 1031 requirement for “like-kind” property exchange.

1031 tax advantages can certainly be favorable, and they have gotten better since 2002, when the IRS expanded the pool of exchange properties with a ruling pertaining to co-owned real estate (CORE) and tenant in common (TIC) structures. With the vast potential upside to a 1031, it is crucial that you the investor seek out experienced tax and exchange professionals to complete your business effectively and safeguard your money. In this way you can execute your exchange efficiently and enjoy the substantial tax benefits you are legally entitled to.

Information from this article was taken from http://www.allstates1031.com

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