The term deduction refers to a decrease in taxable income due to the expenses or losses incurred during the course of the exchange. A 1031 exchange, also known as a like-kind exchange, is a mechanism that allows an investor to sell a property and reinvest the proceeds into a new property, thereby deferring all capital gain taxes.
These deductions can come in several forms:
- Depreciation Deduction: This is one of the key benefits of 1031 exchanges. When you purchase a replacement property, you reset the depreciation schedule, allowing you to take larger depreciation deductions in the early years of ownership.
- Exchange Expenses Deduction: Some costs associated with the 1031 exchange can be deducted, such as fees paid to a Qualified Intermediary or other professionals assisting in the exchange process.
- Interest and Property Tax Deduction: If you have a mortgage on the replacement property, the interest paid on the loan can often be deducted. Similarly, property taxes are typically deductible.