The following is an example of the 1031 exchange process. The following compares a typical sale and a 1031 exchange:
Bill decided to sell the condominium he has owned for 6 years (relinquished property). The property’s current fair market value (F.M.V.) is $1,500,000; however, at the time he purchased the condo, the F.M.V. was $500,000. After Bill spent $50,000 in capital improvements and the property depreciated by $80,000, his adjusted cost basis was $470,000. Bill was advised by his tax consultant to engage in a tax-deferred exchange.
Bill’s real estate broker discovered an apartment building for $2,750,000 (replacement property). Bill purchased the property using the net proceeds from the sale of his condo within the 180 day period and successfully completed the 1031 exchange. If Bill had sold his condo without using a 1031 exchange, he would have paid $144,500 in federal taxes.
Through the use of a 1031 exchange, Bill deferred his capital gains and depreciation recapture taxes, and had $144,500 more to invest into a replacement property.