When someone chooses to use the rules for a 1031 tax exchange for acquiring a new property, there are a lot of disparate benefits that all come into play. However, an individual needs to carefully look over all of the different options that he or she has access to before deciding that a 1031 tax exchange is what’s best for him or her.
The greatest benefit of a 1031 tax exchange is that it defers the taxes that would be paid on a given investment. Because someone can sell a given property and use the profit from the sale to buy a new property and treat it as an exchange. This means that only the difference in the values from the original sale and the price of the new acquisition are subject to capital gains tax, rather than the entire value of the sale. If the seller re-invests the entire value of the sale then there is, in fact, a complete and total deferral of taxes.
Not Tax Free
Many investors may confuse tax deferral with tax free; they are not the same thing at all. If someone uses a 1031 tax exchange to defer the capital gains tax from a single exchange, then when that new property is sold the capital gains tax for the original as well as the new property both apply. It’s for this reason that some investors might choose to just pay the taxes at the time of the sale. However, if the seller continually purchases properties that qualify for a 1031 tax exchange, then the taxes can be deferred over and over again. They will need to be paid in time, though.
Careful Number Crunching
There is no rule that says a person has to use a 1031 tax exchange when it comes time to acquire a new investment property. However, if someone adds up the values and determines that deferring the taxes till a later date would be more beneficial then it is an option that the IRS provides for those who want to get ahead in the business world. However, it is important that those who use the benefits of a 1031 tax exchange understand their responsibilities under the law. Otherwise it’s entirely possible that they’ll find out what they did wrong when the IRS comes knocking and expecting the repayment of all the taxes that have been deferred thus far.