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Updated almost 7 years ago on . Most recent reply

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Michele G.
  • Ann Arbor, MI
52
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109
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Wrapping my head around 1031s

Michele G.
  • Ann Arbor, MI
Posted
We are planning on selling a SFH rental this year. We have a ton of equity in the property so I am trying to learn about 1031s. Here’s what I calculated using rounded numbers: Cost 150 Cap impr 70 Depr 105 Basis 115 Sales Price 575 Closing costs 40 Cap Gain 420 Depr recapture tax 26 Cap Gain tax (20%) 84 Current loan 200 Am I calculating this correctly? Are we really facing somewhere around $100k in taxes if we don’t do the 1031? What type of property (numbers wise) do we need to be considering in order to avoid paying capital gains? Can we buy 2 properties or does it have to be 1? Does that delay all of the tax due (Depr recapture & cap gains)? What happens when we sell the next property? Do the gains (tax owed) from Prop A keep carrying forward to subsequent properties as long as we follow the rules & invest up? My husband is really concerned about the timeframe. How do we make sure we do all of the steps in the right order at the right time? Is that where the intermediary comes in or is that our realtor’s job? We also have another property with similar numbers. Would it be beneficial for us to consider doing the same with that property?Is there any tax benefit/downside to holding a rental that is fully depreciated? I think that’s all I have for now. I will be spending my foreseeable free time trying to catch myself up on 1031s.

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Logan Allec
  • Accountant
  • Los Angeles, CA
977
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Logan Allec
  • Accountant
  • Los Angeles, CA
Replied

@Michele G. 

Am I calculating this correctly?

Your numbers look good, except your 20% capital gain tax would only be about $79k (20% x the portion of the capital gain not attributable to depreciation recapture).

Are we really facing somewhere around $100k in taxes if we don’t do the 1031?

But yes, all in all, you'd be looking at over $100k in taxes at the federal level alone assuming those values are all correct.  (Don't forget state taxes.)

What type of property (numbers wise) do we need to be considering in order to avoid paying capital gains?

If you want all gain deferred, you must meet two criteria in terms of the property acquired.

The first criteria is that the value of the replacement property (or properties) have to exceed or equal your net sales price, which in your example would be $535k ($575k - $40k).

The second criteria is that you must reinvest all of your net proceeds after mortgage.  I couldn't give you a number here since I'm not sure if your property had a mortgage and if so how much.

Can we buy 2 properties or does it have to be 1?

You can exchange into multiple properties, though there are additional rules if you want to identify more than three as potential replacement properties.

Does that delay all of the tax due (Depr recapture & cap gains)?

Yes, the 1031 exchange has the potential to defer all taxes, both depreciation recapture and the other capital gains.

What happens when we sell the next property?  Do the gains (tax owed) from Prop A keep carrying forward to subsequent properties as long as we follow the rules & invest up?

Yes, if you keep on doing 1031 exchanges, and Congress doesn't kill the provision, you can potentially defer all taxes indefinitely.

How do we make sure we do all of the steps in the right order at the right time? Is that where the intermediary comes in or is that our realtor’s job?

The intermediary will hopefully educate you on the 1031 sequence, but the realtor of course can't be asleep at the wheel when it comes to identifying potential replacement properties and ensuring they close within the appropriate timeframe.

We also have another property with similar numbers. Would it be beneficial for us to consider doing the same with that property?

Sure, if you've already made the business decision to sell it and acquire a new property (this decision should be made first apart from any tax implications).

Is there any tax benefit/downside to holding a rental that is fully depreciated?

Well, you no longer get the depreciation deduction.

Keep in mind that in a 1031 exchange the basis from the relinquished property (or properties), called the "exchanged basis," carries forward to the replacement property (or properties).  It's not like you get to reset depreciation on that piece.

However, if you have additional basis in the replacement property (or properties), called the "excess basis" (say you put more cash into the deal), then that piece would generally get a fresh start depreciation schedule.

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