Our deal lawyer Si Yang, Esq. delivered a speech on 1031 Exchange during the 2017 Financial Management Expo event held at Hotel Hyatt Place in Flushing.
What is 1031 Exchange
1031 is the section number of our federal tax code. You know people love it when people calling a statute by its section number like a nickname (another example would be 506(b) and (c) exemption in securities law and private funds). It's probably one of the most popular tax deferral tool for real estate investors and commercial land owner. Here is how it works in a nutshell: you sell a real property and use the proceeds to purchase a new one within 180 days after the first closing. You will not be able to touch a penny from the proceed of the first closing, but if you follow the rules, you will be allowed to defer the payment of the tens of thousands of capital gain tax that you would have to otherwise pay.
“Collecting more taxes than it's absolutely necessary is legalized robbery.” -- Calvin Coolidge
What benefits investors can get from 1031
The benefits are obvious: every penny of tax you defer from the first sales will be used to invest in the loan down payment of the second property, and the benefit will be further amplified by your loan leverage.
Consider the following oversimplified example: you incurred $50,000 capital gain from your sales of your first investment property that would have been otherwise payable after closing. Luckily, you have read this article and planned out with your attorney to use 1031 exchange . When purchasing the exchanged property, you applied for a mortgage with a cash/loan ratio of 25/75. Since now you have additional $50,000 to deploy as loan down payment, you can obtain $150,000 additional loan amount from your bank. The result is a whopping $200,000 increase in your available cash flow which will enable you to lock in a much more premium investment property.
Like all other legal tools and procedures, there are stringent rules you have to follow and there will be exceptions to exceptions. Therefore, consulting a legal counsel and planning your investment ahead of time is of critical importance.
Law Offices of Fuqiang Zhang, P.C. is a transaction-focused law firm based in New York. We specialize in a variety of practice areas such as real property law, corporate and business law, fund and securities law, estate planning, etc. Call us at 718-321-7130 or fill out the form today to get a 15 min free consultation today!