Benefits Of A 1031 Exchange
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Don't sell your income or investment property until you do the Math

The benefit of doing an exchange is to defer paying capital gains tax while diversifying and leveraging your portfolio.  In order to defer paying your capital gains tax, you need to reinvest both your basis and your gain, not just the net proceeds. It is possible to sell property without realizing much profit and still owe substantial capital gains tax. Capital gain is simply the difference between the sales price and the adjusted basis (i.e., what you paid for the property, plus amounts spent on capital improvements, less depreciation taken) less any closing costs associated with the sale.

To calculate your estimated capital gain – first subtract the adjusted basis from the sales price; then subtract the costs of your transaction, commission, fees, transfer tax, etc.; finally, multiply the capital gain by your combined tax rates (Federal and State) to determine your estimated capital gain tax.

  1. Calculate Net Adjusted Basis:
    Example
    Original Purchase Price    $400,000
  Plus Capital Improvements    $25,000
  Minus Depreciation Taken    ($175,000)
  Equals Adjusted Basis    $250,000
  1. Calculate Capital Gain:
      
  Current Sales Price    $600,000
  Minus Exchange Expenses    ($30,000)
  Minus Adjusted Basis    ($250,000)
  Equals Capital Gain    $320,000
  1. Calculate Capital Gain Tax:
      
  Gain Attributable to Depreciation
($175,000 x 25% = depreciation)		    $43,750
  Plus Federal Capital Gain Tax
($320,000-$175,000 = $145,000 x 15%)		    $21,7501
  Plus State Capital Gain Tax
(e.g. CA approx. 10% x $320,000 [cap. gain])		    $ 32,000
  = Combined Tax Due    $97,500

The formula set forth above is provided to help you determine your approximate gain and the sums that you may wish to defer through your exchange transaction. Consult with your tax advisor to determine the correct values and whether an exchange is appropriate for your circumstances.

100% Deferral

To fully defer state and federal capital gain taxes, the Exchanger must reinvest all exchange proceeds and either acquire property with equal or greater debt or reinvest additional cash equal to the debt relief. The following worksheet is a useful tool for determining the amount of cash and debt that should go into the replacement property.

RELINQUISHED PROPERTY    Example
Sale Price:    $400,000
Minus Existing Loans:    $150,000
Minus Exchange Expenses:    $25,000
Equals Net Proceeds:    $225,000
      
REPLACEMENT PROPERTY    Example
Purchase Price:    $600,000
Minus New Loans:    $375,000
Equals Minimum Down:    $225,000

Your minimum down payment for the replacement property should be equal to or greater than the net proceeds from the sale of your relinquished property. Otherwise, you may have boot in the form of cash.

1 Applicable capital gains rates are as follows:
  Federal tax brackets 25%, 28%, 33% or 35%    = 15% capital gains tax
  Federal tax bracket 39.6%    = 20% capital gains tax

 

  Plus, the 3.8% medicare surtax as follows:
  If your AGI is above the threshold amounts specified in IRC §1411, you will pay 3.8% surtax on either your net investment income or your excess AGI over the specified threshold – whichever is less.
  Single taxpayers with AGI’s over $200,000 and married taxpayers with AGI’s over $250,000 will be subject to the 3.8% surtax in addition to paying either 15% or 20% capital gains tax.