Exchanging Thoughts

Taxable Sale vs. 1031 Exchange: Impact of New and Higher Taxes

Posted by Margo McDonnell on Fri, Feb 01, 2013

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By none, we have all heard quite a bit about the American Taxpayer Act of 2012 and the new 3.8% Medicare Tax.  Now let’s take a look at an example and see how a 1031 tax-deferred exchange might benefit the seller:

ASSUMPTIONS

  • Single individual taxpayer owned property for many years
  • Annual Salary of $125,000 and $50,000 of additional income (interest, dividends, rental income)
  • Paid $250,000 for the property a number of years ago
  • Made no capital improvements
  • Depreciated down to $100,000
  • Selling for $500,000 (Capital gains of $250,000)
  • With $175,000 of income, falls into 20% capital gains tax rate
  • Subject to 3.8% Medicare Tax
  • Subject to highest income tax bracket of 39.6%
  • Deprecation recapture of $150,000 @ 25%
  • Would likely face a phase out of Personal Exemptions and be subject to AMT and the Pease limitations
 

Taxable Sale

1031 Exchange

Sale Price

$500,000

$500,000

 

Capital Gains

$37,500*

0

 

3.8% Medicare Tax

$9,500

 

 

Depreciation Recapture

$37,500

0

 

Federal Tax Liability

$84,500

0

 

Net Proceeds

$415,500

$500,000

 

Buying Power (putting 30% down)

$1,385,000

$1,666,667

 

         

*Capital gain taxes are estimated at $250,000 x 15%.  The actual taxes would likely be slightly more because a portion of his gain will be taxed at new 20% bracket.  For taxpayers with taxable income over $400,000, the gain is taxed at 20% but anything under the $400,000 is still taxed at the 15%. 

RESULTS

  • Immediately defers a $84,500 federal tax liability
  • Able to reinvest all proceeds into a replacement property
  • Would also defer state income tax/gain (except in PA, VT and AR)
  • Leverage extra $84,500
  • Acquire new property worth $281,667 MORE than you could if you paid the tax
  • Collect higher rents from Day 1
  • More depreciation available
  • Enjoyed greater appreciation long-term

A 1031 exchange is a powerful tax strategy for investors and business owners.  In addition to the tax deferral, 1031 exchange provide many other benefits.

Every exchange is different and it is essential to discuss your situation with a tax advisor but the 1031 CORP. Exchange Team is always available to answer your exchange questions.

Topics: tax consequences of a 1031 exchange