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Deferring Losses On The Sale of Property Using 1031 Exchanges

The 1031 exchange allows you to sell qualified use property that has been held for rental, investment or use in your trade or business and defer the payment of your depreciation recapture and capital gain taxes by acquiring other investment property.

1031 Exchange Is A Wealth Building Strategy

The ability to defer your taxable gains by using the 1031 exchange strategy has obvious wealth building benefits by allowing you to keep 100% of your equity or cash invested and working for you so that you can trade up into more profitable investment property. 

Deferring Losses On The Sale Of Investment Property

What happens if the disposition or sale of your investment property actually results in a net loss to you?  The majority of taxpayers would want to take advantage of the loss by recognizing it on their income tax returns immediately, which is generally the best course of action.  However, is there ever a time where you might want to defer the recognition of the loss? 

Structuring A 1031 Exchange Will Defer A Gain Or Loss

The answer is "perhaps," but you must be sure before you proceed.  Structuring the disposition or sale of any investment property as a 1031 exchange will require that the income tax consequence be deferred whether it is a gain or loss.  You can not change your mind when you complete your income tax return and realize that you actually have a loss.  The loss must be deferred if the disposition or sale was structured as a 1031 exchange transaction. 

Know The Tax Consequences Before Proceeding

This is why you should always consult with your personal tax counsel prior to completing any disposition or sale of investment property.  You need to know exactly what your income tax consequences will be from the disposition or sale of the investment property before you proceed with the transaction.  You can always change or alter the transaction structure based upon guidance from your tax counsel prior to closing, but you can not change the structure once you have closed on the disposition or sale of the investment property. 

Deferring A Loss On Investment Property

However, there are certain reasons why you may want to defer a loss on the disposition or sale of your investment property. 

You may already have certain loss carry forwards on your income tax return, which may only be carried forward for a limited number of years for certain types of taxpayers.  You may be concerned that you would end up losing the benefit of the additional loss recognized from the disposition or sale of your investment property should you recognize the loss now. 

Postponing the recognition of a loss on the disposition or sale of investment property into a future tax year may provide better tax benefits if you expect to be in a higher tax bracket in the future.  This strategy involves a certain amount of guess work since you have no control over the income tax rates that may be in effect for future tax years. 

There could be a variety of other reason for which you may not want to recognize the loss for income tax purposes in the current tax year and structuring the disposition or sale of your investment property may be appropriate. 

Deferring losses from the disposition or sale of your investment property may be a prudent tax planning strategy under certain circumstances.  Again, you should always consult with your personal tax counsel prior to structuring or completing any disposition or sale of investment property.  It is always prudent to be proactive in order to stay ahead of the game.

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