Benefits Of A 1031 Exchange
Do the Math | 100% Deferral
Don't sell your income or investment property until you Do the Math
Taxes are paid on capital gain, not equity or profit. 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.
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1. Calculate Net Adjusted Basis: |
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Example |
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Original Purchase Price |
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$400,000 |
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Plus Capital Improvements |
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$25,000 |
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Minus Depreciation Taken |
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($175,000) |
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Equals Adjusted Basis |
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$250,000 |
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2. Calculate Capital Gain: |
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Current Sales Price |
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$600,000 |
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Minus Exchange Expenses |
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($30,000) |
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Minus Adjusted Basis |
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($250,000) |
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Equals Capital Gain |
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$320,000 |
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3. Calculate Capital Gain Tax: |
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Gain Attributable to Depreciation
($175,000 x 25% = depreciation) |
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$43,750 |
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Plus Federal Capital Gain Tax
($320,000-$175,000 = $145,000 x 15%) |
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$21,7501 |
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Plus State Capital Gain Tax
(e.g. CA approx. 10% x $320,000 [cap. gain]) |
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$ 32,000 |
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= Combined Tax Due |
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$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.
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RELINQUISHED PROPERTY |
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Example |
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Sale Price: |
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$400,000 |
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Minus Existing Loans: |
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$150,000 |
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Minus Exchange Expenses: |
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$25,000 |
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Equals Net Proceeds: |
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$225,000 |
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REPLACEMENT PROPERTY |
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Example |
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Purchase Price: |
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$600,000 |
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Minus New Loans: |
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$375,000 |
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Equals Minimum Down: |
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$225,000 |
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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.
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1 |
Applicable capital gains rates are as follows: |
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The applicable Federal capital gains rate may be 15% or 20% depending on your income and filing status. |
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Plus, the 3.8% medicare surtax as follows: |
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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.
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