On this Thankful Thursday, we will still talking about the bill that averted the fiscal cliff which is officially known as the “American Taxpayer Relief Act of 2012.” Yesterday’s post provided an overview of the bill but today we are discussing what 1031 exchangers are most interested in: CAPITAL GAINS and ESTATE TAXES.
Capital Gains
Capital gains did go up for higher earners but not everyone. Long-term capital gain tax rates will increase to 20% for individual taxpayers with more than $400,000 in taxable income and married couples with $450,000. (These higher earners will also fall into the new 39.6% income tax bracket.) The capital gain tax rates will remain 15% for those in the 25%, 28%, 33% and 25% income tax brackets and those in the 10% and 15% income tax brackets will continue to have a zero rate.
The higher capital gain tax rate is in addition to the new 3.8% Medicare Tax that kicked in January 1st as part of the health care reform. This new tax applies to single taxpayers with incomes or an adjustable gross income (AGI) over $200,000 or $250,000 for married couples. The provision imposes a 3.8% tax on interest, dividends, annuities, royalties and rents which are not derived in the ordinary course of trade or business, excluding active S corporation or partnership income.
This means, effective immediately, that many investors and business owners will be taxed at 18.8% or 23.8% not 15%.
Solution: When selling assets held for business use or investment, a 1031 exchange will defer the gain provided like-kind replacement property is acquired. A 1031 exchange allows you to defer the capital gain and the 3.8% Medicare Tax as well as the 25% depreciation recapture.
Estate Tax
One of the least known benefits of a 1031 exchange is the possibility that the deferred gain may be forgiven. How does that happen? When does the deferred gain catch up to you? When exchanging, the gain is deferred as long as the replacement property is held. When selling that replacement property, assuming the property is still held for business use or investment, it may be exchanged and the gain (from the old property as well as this replacement property) deferred again. If the property is sold rather than exchanged, the tax comes due.
So what happens if the replacement property is held for the rest of the taxpayer’s life? When a taxpayer dies, his/her heirs receive the assets with a stepped up basis (the full value of the asset at the time of death). This means all of the gain deferred during the taxpayer’s life is forgiven and no one has to pay back the deferred gain.
Of course, we have to think about estate taxes but the first $5,000,000 of one’s estate is exempt of estate taxes. We expected the $5,000,000 exemption to be reduced but under the new bill, the $5,000,000 stays. Anything above the $5,000,000 is taxed at 40% which up from 35%. This $5,000,000 exemption is excellent news for those who take advantage of 1031 exchanges to build their portfolio with pre-tax dollars and want to pass those assets to their heirs.
The power of a 1031 exchange just got a little mightier! Contact 1031 CORP.. and let us put this power to work for you.
