Let’s assume that you purchased an investment property for $500,000 and you have held the investment for 10 years. To keep things simple for this example we will assume that you payed cash and you have not mortgaged the property. The value of the property now is $1,000,000. To minimize your taxes over the 10-year holding period you have accumulated $182,000 in depreciation. Let’s calculate your capital gain If you were to sell the property today for $1,000,000.
| Purchase Price (Basis) | $ 500,000 |
| Accumulated Depreciation | $ 182,000 |
| Adjusted Basis | $ 318,000 |
| Sale Price | $ 1,000,000 |
| Sales Costs | $ 70,000 |
| Net Proceeds | $ 930,000 |
| Minus Adjusted Basis | $ 318,000 |
| Capital Gain | $ 612,000 |
You have a Capital Gain of $612,000… Congratulations, assuming you are in the top marginal tax rate for 2019 of 37% you will have a capital gains tax liability of 20% or $122,400.
Enter the 1031 exchange.
Your $612,000 proceeds from the sale of the (relinquished property) is placed with a (Qualified Intermediary).
Essentially, you now have 45 days to identify a potential (replacement property) or properties and have 180 days to complete a purchase totaling $1,000,000 and put that $612,000 to work as equity in the replacement property or properties and subsequently avoiding the capital gains liability… for now.
If you sell the replacement property in the future you will be responsible for the capital gains tax at that time unless of course you elect to do another 1031 exchange. I have had clients roll gains in to 1031 exchanges multiple times over the years and many investors elect 1031’s as a matter of course.
Fees charged by Qualified Intermediaries are very reasonable, generally in the $1,000 to $2,000 range. I have worked with several over the years and would be happy to refer one if you have any questions. Of course, my example above covers the basics and you should consult a 1031 Tax specialist and your CPA for specifics.
Happy Investing
Pete Doiron
Broker – Doiron Realty Services