Take the Tax Hit or 1031?

1031 Exchanges
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Take the Tax Hit or 1031?

Will BarnardPro Member
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Developer · Santa Clarita, CA · Member since 2008 · 15k+ posts · 10k+ votes

I have a problem and would love to hear some opinions on this.
Here is the scenario: a $1.5M tax exposure (net profits on sale of property) and a lack of desire to pay Uncle S. and CA 50% of that ($750k).

So the question is, would you pay the tax and keep gong or would you 1031 exchange this into a buy and hold deal (perhaps commercial deal or 100+ unit apartment building) to avoid the tax?

If you pay the tax, keep in mind you would have until next year to pay it so perhaps take the $1.5M and reinvest into more deals that would net profits to pay s the tax so at the end of the day, perhaps you would still be left with $1.5M or 1031 and with the buy and hold, obtain cash flow passively to semi passively for years to come and not pay any tax.

Your thoughts are appreciated.
- Will Barnard

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Carl Schmitt
CT · Member since 2010 · 135 posts · 100 votes
13y

I don't know much about 1031 so I could be way off. However, is it possible to take the 1.5 mil, buy a property all cash using a 1031, wait the year to meet seasoning requirements, and then cash out refi the property? You wouldn't be able to take 100% out obviously, but 75% out with 25% equity is better than 50% to Uncle Sam.

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  • Steven Hamilton IIPro Member
    Accountant, Enrolled Agent · Grayslake, IL · Member since 2011 · 5k+ posts · 2k+ votes
    13y

    You simply have to do an annualized sourcing of your income and it should not be an issue.

    -Steven

    [email protected]224-381-2660
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  • Will BarnardPro Member
    Moderator
    OP
    Developer · Santa Clarita, CA · Member since 2008 · 15k+ posts · 10k+ votes
    13y

    Agreed.

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  • Dave Toelkes
    Investor · Pawleys Island, SC · Member since 2008 · 1k+ posts · 837 votes
    13y

    Will Barnard,

    I like the idea of a 1031 exchange if I never plan to sell the replacement property. However, since you have another use for the proceeds of the sale and would eventually sell anyway, it seems more prudent to sell now and pay a 15% capital gain to the IRS and 9%(?) to CA. I don't see that this adds up to 50%, but it might if you wait to sell in a future year. Is it next year when the 3.8% medicare surcharge on investment income will also go into effect? The capital gains tax rate goes up to 20% on Jan 1, 2014 and Congress could raise the rate even higher in a future year when you might be selling your 1031 exchange replacement property.

    My vote is pay the tax now while the tax rate is as cheap as it is going to be for several years to come.

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  • Steven Hamilton IIPro Member
    Accountant, Enrolled Agent · Grayslake, IL · Member since 2011 · 5k+ posts · 2k+ votes
    13y

    Dave T,

    It has gone up officially. And it wouldn't now be capital gains right now it would be flip income.

    [email protected]224-381-2660
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  • Bill ExeterBusiness Member
    1031 Exchange Qualified Intermediary · San Diego, CA · Member since 2008 · 1k+ posts · 1k+ votes
    13y

    Capital gain tax rates already went up to 20% effective January 1, 2013 and the Medicare Surcharge Tax also went into effect. California does not have a capital gain tax rate and California's top ordinary tax rates are now tiered from 9.3% to 10.3%, 11.3%, 12.3% and 13.3% depending on your AGI.

    So, assuming that you are in the top tax brackets, you are looking at:

    Federal 20.0%
    Obamacare 3.8%
    California 13.3%

    Total 37.1%

    The 0% and 15% capital gain tax rates are in effect through this year, but with gain that you are talking about you will be in the top brackets.

    Exeter 1031 Exchange Services, LLC and Exeter Trust Company4.726 Reviews
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  • Dave Toelkes
    Investor · Pawleys Island, SC · Member since 2008 · 1k+ posts · 837 votes
    13y
    Originally posted by Bill Exeter:

    The 0% and 15% capital gain tax rates are in effect through this year, but with gain that you are talking about you will be in the top brackets.

    Bill,

    For 2013, the 20% rate only kicks in at $400K/$450K right?

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  • Will BarnardPro Member
    Moderator
    OP
    Developer · Santa Clarita, CA · Member since 2008 · 15k+ posts · 10k+ votes
    13y

    Dave, both Bill and Steven nailed it, plus, since my sale is not capital gains but ordinary income, the top tax bracket in the Fed column that Bill listed is much higher. 38% I believe, bringing my total above 50%

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  • Mark Ferguson
    Flipper/Rehabber · Greeley, CO · Member since 2013 · 2k+ posts · 1k+ votes
    13y

    Will Barnard, I don't think I saw this in the previous posts but can't you refinance off of your purchase price right away. My lender will let me refi 75% off the purchase price no matter how long ago I bought it. If I want to do 75% of the appraised value and refi off more than the purchase price then I have to wait a year.

    0Reply
  • Steven Hamilton IIPro Member
    Accountant, Enrolled Agent · Grayslake, IL · Member since 2011 · 5k+ posts · 2k+ votes
    13y
    Originally posted by Bill Exeter:
    Capital gain tax rates already went up to 20% effective January 1, 2013 and the Medicare Surcharge Tax also went into effect. California does not have a capital gain tax rate and California's top ordinary tax rates are now tiered from 9.3% to 10.3%, 11.3%, 12.3% and 13.3% depending on your AGI.

    So, assuming that you are in the top tax brackets, you are looking at:

    Federal 20.0%
    Obamacare 3.8%
    California 13.3%

    Total 37.1%

    The 0% and 15% capital gain tax rates are in effect through this year, but with gain that you are talking about you will be in the top brackets.

    Also, that said, If you are int he 39.6% bracket, you are looking at

    Federal: 39.6%
    Cali : 13.3%

    Total : 52.9%

    Thank you may I have another.

    Back to tax returns....

    [email protected]224-381-2660
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  • Michael Heisterkamp
    Arlington, TX · Member since 2013 · 62 posts · 11 votes
    13y

    Why pay Uncle Sam, he can't manage a check book in anyway shape or form. I am not for anyone funding a drunken sailor on shore leave.

    1031

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  • Will BarnardPro Member
    Moderator
    OP
    Developer · Santa Clarita, CA · Member since 2008 · 15k+ posts · 10k+ votes
    13y
    Originally posted by Mark Ferguson:
    Will Barnard, I don't think I saw this in the previous posts but can't you refinance off of your purchase price right away. My lender will let me refi 75% off the purchase price no matter how long ago I bought it. If I want to do 75% of the appraised value and refi off more than the purchase price then I have to wait a year.
    You must have missed the important details here. This is something I am selling to obtain the profit, holding it does me no good, it certainly would not cash flow, thus a refi is out of the question.

    This is a flip and the profits can only be obtained via sale.

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  • Mark Ferguson
    Flipper/Rehabber · Greeley, CO · Member since 2013 · 2k+ posts · 1k+ votes
    13y

    Right. I meant sell it, do 1031 exchange for cash. Then refi in a month or two to get your cash out for other properties based off 75% of the purchase price of the new property/properties.

    0Reply
  • Cheryl C.
    Investor · Reston, VA · Member since 2011 · 683 posts · 191 votes
    13y

    You have to hold it for a rental - not sure the time period, but I always heard one year was safe. If it's inventory, the gain is ordinary income. Best to check Steven Hamilton II. I've done many 1031's and hope to die with the deferred taxes given a new basis via inheritance. If this is what even happens(?). That said, who the heck knows what will happen to the tax code down the road.

    1Reply
  • Bill ExeterBusiness Member
    1031 Exchange Qualified Intermediary · San Diego, CA · Member since 2008 · 1k+ posts · 1k+ votes
    13y
    Originally posted by Dave T:
    Originally posted by Bill Exeter:

    The 0% and 15% capital gain tax rates are in effect through this year, but with gain that you are talking about you will be in the top brackets.

    Bill,

    For 2013, the 20% rate only kicks in at $400K/$450K right?

    Yes, correct.

    Exeter 1031 Exchange Services, LLC and Exeter Trust Company4.726 Reviews
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  • Bill ExeterBusiness Member
    1031 Exchange Qualified Intermediary · San Diego, CA · Member since 2008 · 1k+ posts · 1k+ votes
    13y
    Originally posted by Troy Fisher:
    Will Barnard, here's what I understand about 1031, it's like the rest of the law; Intent is 90% of the law. If you can prove that you intended to hold the property for 357 days but market situation changed... best to talk to a 1031 specialist or your RE Lawyer at this point.

    Hi Troy,

    You are right about intent. However, you do not need to prove that you had the intent to hold for 357 days. The key is that you have to prove your intent to hold for investment. Most experts and advisors recommend a holding period of 12 months or more because it makes it easy to prove that you had the intent to hold, but it is not a black and white definition or test.

    Exeter 1031 Exchange Services, LLC and Exeter Trust Company4.726 Reviews
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  • Bill ExeterBusiness Member
    1031 Exchange Qualified Intermediary · San Diego, CA · Member since 2008 · 1k+ posts · 1k+ votes
    13y
    Originally posted by Will Barnard:
    Dave, both Bill and Steven nailed it, plus, since my sale is not capital gains but ordinary income, the top tax bracket in the Fed column that Bill listed is much higher. 38% I believe, bringing my total above 50%

    Yep, that's right (and painful).

    Exeter 1031 Exchange Services, LLC and Exeter Trust Company4.726 Reviews
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