Let us understand this in detail considering the following example –
After a deal is closed, you as an investor have $400,000 in gain and $400,000 in net proceeds. Ideally, a $400,000 capital gain incurs a tax liability of approximately $140,000 in taxes which includes federal capital gain tax, state capital gain, tax depreciation recapture, and income tax on net investment, when a property is sold. $260,000 is what will remain in net equity to reinvest in a different property.
Let us consider a 25% down payment and availing on new financing for the acquisition with a 75% loan-to-value ratio, in this case, you will only be able to purchase a $1,040,000 replacement property.
However, if you chose to exchange, you will be able to reinvest the entire gross equity of $400,000 in the purchase of $1,600,000 replacement property, considering the same down payment and loan-to-value ratios.
As the preceding example explains, tax-deferred exchanges enable investors to defer capital gain taxes as well as promote meaningful portfolio growth and increases return on investment.
The benefits of 1031 exchanges sale can be notable for taxpayers who hold investment property. Taxpayers could defer all capital gain taxes, depreciation recapture, the net investment income tax (NIIT), and state taxes. Once the requirements of a valid 1031 exchange are met, capital gain recognition can be delayed until the taxpayer wishes to recognize it.
For instances, a married couple filing jointly trades an investment property in California for $1,000,000 (net of closing costs) with no debt. The couple incipiently acquired the property for $400,000. Seventy-five percent, or $300,000 of the initial purchase price, was designated to the building and has been fully depreciated. The capital gain is around $900,000 (today’s sales price of $1,000,000 minus the net adjusted basis of $100,000). This is the primary source of the couple’s investment income. The couple’s modified adjusted gross income is $1,400,000 (which includes income from other sources and capital gain from this sale) for purposes of calculating the net investment income tax. The couple will be taxed at 25% for their prior depreciation deductions taken, 20% federal capital gains tax rate, the 3.8% net investment income tax and they will be in the 13.3% California state tax bracket.
The benefits of IRC Section 1031 exchanges are enormous! Conversely, the impact of not doing an exchange can be simply mortifying. Investors are often qualified to delay hundreds of thousands of dollars in capital gain taxes, both at federal and state levels.
1031 Exchange enables your money to churn the maximum profit for you. However, the exchange process is extremely complex in nature and it would be wise to seek guidance from expert professionals. We have extensive experience in handling highly profitable exchanges for our varied client base.
For consultation and assistance regarding 1031 exchange call 888-993-2835 or email us at info@1031Xchange.com