Real Estate Investment Software

In any real estate investment transaction, the property owner (seller) is taxed on the gains from the sale. However, through a Section 1031 Exchange, the tax on the gain is deferred.

Section 1031 of the Internal Revenue Code provides that no gain or loss shall be recognized on the exchange of property held for productive use in a trade or business, or for investment. A tax-deferred exchange is a way for a property owner to trade properties for one or more replacement properties of “like-kind”. 1031 exchanges will defer federal and state taxes because it would be unfair to force the taxpayer to pay tax on a “paper” gain.

The like-kind 1031 exchange is tax-deferred, not tax-free. When the exchanged property is finally sold (not as part of another exchange), the original deferred gain, plus any additional gains since the purchase of the exchanged property, will be taxed.

The capitalization rate, a.k.a the–cap rate–is a way of measuring the ratio between cash flows an real estate investment property and the purchase price, or alternatively its current fair market value. Here is the formula for the cap rate:

* annual cash flow / cost (or value) = Capitalization Rate

For example, if a building is purchased for $500,000 and it produces $50,000 in positive net cash flow (costs are subtracted from gross income) during a year, then:

* $50,000 / $500,000 = 0.10 = 10%

The capitalization rate is ten percent.

The capitalization rate is measuring how fast an investment will pay back the original purchase price. from net cash flows. In the example above, the purchased building will be fully capitalized (pay for itself) after five years (100% divided by 10%). If the capitalization rate were 5%, the payback period would be twenty years.

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