Won't I have to pay taxes eventually anyway...?
Many people ask the question, "Won't I still have to pay the capital gain taxes on my property when I eventually sell it? So what is the difference if I pay them now or later?"
The Answer: Yes it is true that the taxes you deffered today will still be due in the future when you resell your property. The greatest benefit from a 1031 occurs in the period of time in which you are holding your property. The taxes that you would have otherwise paid to the government are now working to make you money. This is called financial leveraging. Let me illustrate in an example:
Table 1 (Sold with a 1031 exchange)
| Property 1 Price | 1,000,000 |
| Gain (20%) | 200,000 |
| Sell Price | 1,200,000 |
| Capital Gain | 200,000 |
| Tax Rate | 18% |
| Tax Liability (18%)* | 36,000 |
*18% = 15% federal tax rate plus a 3% state tax rate.
In Table 1 the individual sells their investment property 1 after making a gain and working with a QI (Qualified Intermediary). This starts the 1031 exchange. The tax liability of $36,000 is then rolled into the next property that they purchase, property 2.
Table 2 (Purchased with a 1031 exchange)
| Property 2 Price | 1,200,000 |
| Gain (20%) | 240,000 |
| Deferred tax liability | 36,000 |
| Gain on property (20%) | 20% |
| Amount made on deferred taxes | $7,200 |
In Table 2 the individuals’ new investment property 2 is now making them money much like property 1, EXCEPT that the amount owed in taxes that was deferred is now making money also.
--The Experts
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