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1031 Exchange Calculator

Figure Your Tax Deferred Benefits

This calculator will help you to determine how much tax deferment you can realize by performing a 1031 tax exchange instead of a taxable sale.

Original purchase price ($):
Capital improvements ($):
Accumulated depreciation ($):
Sales price ($):
Selling expenses ($):
Federal capital gains rate (%):
State capital gains rate (%):
Loan balances at sale ($):
Your Calculation Results
Net adjusted basis:
Capital gain:
Depreciation recapture (25%):
Federal capital gains tax:
State capital gains tax:
Total taxes due:
Gross equity:
After-tax equity:
Sale reinvestment (after-tax equity X 4):
Exchange reinvestment (gross equity X 4):

 

 

Everything You Need to Know About 1031 Exchanges

1031 tax-deferred swaps allow real estate investors to defer paying capital gains taxes when they sell a property that is used "for productive use in a trade or business," or for investment.

This is due to IRC Section 1031, and when structured correctly, it lets you sell a property and reinvest the proceeds in a new property - while deferring all capital gains taxes.

First, let's look at the letter of the law and see how it applies to the average investor:

Section 1031 -- Exchange of Property Held for Productive Use or Investment

(a) Non-recognition of gain or loss from exchanges solely in kind --
(1) In general --
No gain or loss shall be recognized on the exchange of property held for productive use in a trade or business or for investment if such property is exchanged solely for property of like kind which is to be held either for productive use in a trade or business or for investment.

What Are the Benefits of a Tax-Deferred Swap?

By avoiding capital gains taxes when you sell a property to reinvest in another similar property, you get to keep 100% of your equity. But there are other reasons to take advantage of swaps.

  • Trade up - when you switch a high equity position to reinvest in a much larger property with some financing, in order to increase your return on investment.
  • Diversify - when you trade up from property in one part of town (or one sector) into another. For example, when you diversify by trading up from residential units to a retail strip mall.
  • Management relief - you can sell off "high-maintenance" properties and invest in an apartment complex which has a live-in manager, or a similar management-free replacement property.

How an Exchange Can Benefit You

Real Estate Growth.

Let's suppose you have a capital gain of $200,000 and incur combined taxes from federal and state capital gains taxes, and a depreciation recapture of $70,000 when the property is sold. That leaves you with only $130,000 to invest in another property.

In this scenario, you would only be able to purchase a property worth $520,000. This is based on a down payment of 25% and a loan-to-value ratio of 75%.

However, if you chose to switch, you would have the entire $200,000 equity to sink into a new property, which would allow you to buy $800,000 worth of real estate - using the same down payment percentage and loan-to-value ratio.

We can see here that the 1013 arrangement is a form of protection because it shields investors from capital gains taxes, and it offers a greater return on investment. In order to take full advantage of these programs, it's important to understand them fully.

For example, the wording of the swap is open to interpretation, and this can help you expand and diversify your portfolio. Specifically, the phrase "property of like kind" is sometimes (mistakenly) taken to mean the same type of building, but it actually includes many different kinds of properties.

How to Calculate Capital Gains Taxes Owed

Calculating the amount of capital gains taxes owed when you sell a property is a three-step process. Firstly, take the original purchase price, add the cost of improvements, and subtract the depreciation amount. This gives you the net adjusted basis.

Next, you need to determine your actual capital gain by taking the sales price and subtracting both the net adjusted basis and the cost of sale. Now that you have your capital gain, you need to calculate the amount owed.

Finally, use a recaptured depreciation tax rate of 25%, the maximum capital gains tax rate of 15%, and then add the state tax rate (if applicable). The total of the depreciation recapture, the federal tax, and the state tax gives you the amount due for your capital gains tax.

The Rules of Identification

If you do an exchange, you are permitted to name more than one replacement property, but you are limited by the following three rules:

  1. The Three Property Rule. Three replacement properties can be identified regardless of their fair market value.
  2. The 200 Rule. The value of the replacement property is no more than twice the value of the relinquished properties.
  3. The 95% Rule. You can choose any number of replacement properties, as long as the acquired properties equal at least 95% of the fair market value of all identified properties.

Exchange vs. Sale

A 1031 arrangement allows you to defer all of your capital gains taxes. And this amounts to getting a long-term and interest-free loan from the Internal Revenue Service. The real advantage is not just in tax savings - investors who take advantage of 1031 provisions can acquire much more investment real estate than those who don't. The biggest plus is the buying power you';ll have.

The Reverse Exchange

When an investor closes on the purchase of the replacement property before they close on the sale of the old (relinquished) property, it's known as a reverse swap.

It';s a fantastic tool for investors who are looking to quickly replace their property in a seller's market when there may be many offers pending on the property.

There are several different options, including the parked replacement property option, the reverse improvement swap, and the parked relinquished property alternative.

The Definition of Like-Kind Property

Like-kind properties are those considered to have similar business or investment uses. Examples are:

  • Trading up from an unimproved property to an improved one
  • Trading up from vacant land to a commercial building
  • Trading up from a single family unit to a small apartment building

Time Limits of a Delayed Exchange

A delayed switch is one in which the investor closes on the sale of their relinquished property on a certain date, and then purchases a replacement property at a later date. An investor has a maximum of 180 days, or their filing deadline (whichever comes first), to complete the purchase of the replacement property.

This is known as the exchange period, and there is also an identification period, which is limited to 45 days after closing on the old property. These 45 days of identification are included in the 180-day exchange period.

lightbulb. Use our 1031 deadline calculator to figure your deadlines. lightbulb.

The Improvement Exchange

This allows you as an investor to make improvements on the replacement property using equity from the 1031. This is normally done through a qualified third party. By using this option, you can end up with a much more lucrative investment property than what's available on the market.

You can use your swap equity to do major renovations, capital improvements, or even build from the ground up - all financed by tax-deferred dollars.

Selecting a Qualified Intermediary

A qualified intermediary (QI) is someone who facilitates your 1031 transaction. Of course, you should choose the person offering the highest security for the transaction proceeds that will be held in their possession during the exchange period.

This is very important because the federal government doesn't regulate qualified intermediaries, so you should do some diligent research. Find out how many years they've been in business, how many exchanges they've overseen, and how proficient they are as a whole.