The Advantages of a 1031 Tax Deferred Exchange Leverage

When you sell your interest in an investment property and buy another, you may face a large capital gain and the prospect of paying federal taxes on it—and in some states, state taxes as well. So your attorney, tax advisor, or real estate professional may suggest a tax-deferred exchange under Section 1031 of the Internal Revenue Code.  A 1031 Exchange allows you to dispose of investment properties and acquire “like-kind” properties while deferring federal capital gains taxes. Most states with a capital gains tax offer a similar tax advantage, too. Bottom line: a 1031 Exchange lets you reinvest sale proceeds that would otherwise be paid to the government as capital gains taxes.
 
Let’s assume you acquired a property for $800,000 four years ago. It has a current mortgage balance of  600,000 and has appreciated to $1,800,000. During the period you owned the property you have taken depreciation deductions of $100,000.Your long term capital gains tax would total $175,000 calculated as follows:

$1,000,000 appreciation gain x 15% = $150,000;
$100,000 depreciation recapture x 25% = $25,000.

Example: