Deferred Gain
Detailed Definition
Deferred Gain refers to the realized gain on a property transaction that is not recognized for tax purposes during the transaction. In the context of a tax-deferred exchange (commonly under Section 1031 of the Internal Revenue Code), the taxpayer can defer the tax liability on the capital gains if the proceeds from the sale are reinvested in a like-kind property within a specified period. The deferred gain is essentially carried forward into the newly acquired property, effectively reducing its tax basis and deferring the capital gains tax until a future taxable transaction occurs.
Examples
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Ronald’s Deferred Gain: Suppose Ronald arranges a tax-deferred exchange (also known as a tax-free exchange) where he sells his commercial property, realizing a gain of $1 million. By reinvesting the proceeds in a like-kind property, Ronald defers the recognition of the $1 million gain, meaning he does not pay taxes on it immediately. The deferred gain now carries over to the newly acquired property in the form of a lower tax basis.
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Investment Property Swap: Jane sells her rental property and realizes a gain of $500,000. She reinvests the entire proceeds into another rental property in a different city. Through a 1031 exchange, Jane defers the $500,000 gain, and her new property inherits the lower tax basis reflective of the deferred gain.
Frequently Asked Questions
Q1: What is a tax-deferred exchange?
A: A tax-deferred exchange, also known as a 1031 exchange, allows investors to defer paying capital gains taxes on an investment property when it is sold, provided the proceeds are reinvested into a like-kind property.
Q2: How does a deferred gain impact the tax basis of the new property?
A: The deferred gain reduces the tax basis of the newly acquired property. The lower tax basis means that more gain may be recognized (and taxed) when the new property is eventually sold in a taxable transaction.
Q3: Are there time limits to complete the like-kind exchange?
A: Yes, there are strict time constraints. Typically, the taxpayer must identify the like-kind property within 45 days and complete the exchange within 180 days of selling the original property.
Q4: Can all property exchanges qualify for deferred gains under Section 1031?
A: No, only certain types of investment and business properties qualify for a 1031 exchange. Personal residences and inventories do not qualify.
Q5: What happens if the new property is worth less than the original property’s sale price?
A: If the value of the new property is less, partial deferral occurs, and the difference may be subject to immediate taxation.
Related Terms
- Tax-Deferred Exchange: A type of real estate transaction that allows an investor to defer paying capital gains taxes by reinvesting the proceeds into another like-kind property.
- Realized Gain: The amount of gain generated from the sale of property before accounting for any deferral or recognition.
- Not Recognized: The tax status where the gain is not subject to tax in the current period but may be recognized in the future.
- Section 1031: A section of the Internal Revenue Code that allows tax deferral on qualifying property exchanges.
- Tax Basis: The original value of a property for tax purposes, adjusted for factors such as improvements and depreciation.
Online Resources
- IRS – Like-Kind Exchanges Section 1031: Link to IRS
- Investopedia – 1031 Exchange: Investopedia Article
- National Association of Realtors – 1031 Exchanges Guide: NAR Guide
References
- “Internal Revenue Code: 1031 Exchange.” IRS Publications.
- “The Official Guide to 1031 Exchanges – James D Hamill, Esq.”
Suggested Books for Further Studies
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“The 1031 Exchange Handbook” by Steve Bergsman
This book provides a comprehensive look into the rules, strategies, and applications of 1031 exchanges. -
“Tax-Free Real Estate Investments: How to Achieve Financial Freedom through 1031 Exchanges” by Timothy Harris
A guide to leveraging 1031 exchanges for building real estate wealth while minimizing tax liabilities. -
“Like-Kind Exchanges Under Code Section 1031” by Bradley T. Borden
An in-depth legal text that explores the intricacies of 1031 exchanges within the tax code structure.
