A 1031 exchange is a powerful tool for deferring taxes on the sale of investment properties, including depreciation recapture. When you sell a property, the IRS typically requires you to recapture depreciation deductions you've taken over the years, which are taxed at a higher rate than capital gains. However, a 1031 exchange allows you to defer this depreciation recapture, along with capital gains taxes, by reinvesting the proceeds into a like-kind property.

How It Works

When you sell your investment property, the depreciation you've claimed over the years reduces your property's adjusted basis. This means that when you sell, the difference between the sale price and the adjusted basis is larger, resulting in a higher taxable gain. In a typical sale, you would have to pay taxes on this gain, including the portion attributable to depreciation recapture.

However, by using a 1031 exchange, you can defer these taxes. The key is to reinvest all the proceeds from the sale into a new, like-kind property. This deferral applies to both the capital gains and the depreciation recapture. The deferred taxes are essentially rolled over into the new property, and you won't have to pay them until you eventually sell the replacement property without doing another 1031 exchange.

Example

Imagine you purchased a rental property for $300,000 and over the years, you claimed $100,000 in depreciation. This means your adjusted basis in the property is now $200,000 ($300,000 purchase price − $100,000 depreciation). You sell the property for $500,000. Without a 1031 exchange, you would have a taxable gain of $300,000 ($500,000 sale price − $200,000 adjusted basis), and you would owe taxes on both the capital gain and the $100,000 of depreciation recapture.

• Purchase price: $300,000
• Depreciation claimed: $100,000
• Adjusted basis: $200,000
• Sale price: $500,000
• Taxable gain: $300,000

Now, let's say you decide to do a 1031 exchange and use Deferred.com as your qualified intermediary. We facilitate the exchange by holding the proceeds from the sale of your relinquished property and using them to purchase a new, like-kind property. You find a replacement property for $600,000 and reinvest all the proceeds from your sale into this new property.

By doing this, you defer the taxes on the $300,000 gain, including the $100,000 depreciation recapture. The deferred taxes are now tied to your new property. If you continue to use 1031 exchanges for future property sales, you can keep deferring these taxes indefinitely, allowing you to leverage your full equity for further investments.

No Fee Exchange with Deferred.com

At Deferred.com, we offer a "No Fee Exchange," which means you can save money on the transaction while maximizing your investment potential. By choosing us as your qualified intermediary, you ensure a smooth and compliant exchange process, allowing you to focus on growing your real estate portfolio without the immediate tax burden.

Remember, while a 1031 exchange defers taxes, it doesn't eliminate them. Eventually, when you sell a property without doing another exchange, you'll need to pay the deferred taxes. However, with strategic planning, you can continue to defer taxes and build wealth through real estate investments. Always consult with a tax professional to ensure that a 1031 exchange aligns with your financial goals and tax situation.