Tom Gustafson

Three Easy Steps to Quantifying Capital Gains Tax

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1031 Replacement PropertyTax-Free Exchanges make sense when federal and or state capital gains taxes and recaptured depreciation exist.  Are they really tax free?  No, the taxes are simply delayed or postponed until the replacement property sells.  Another 1031 exchange can be initiated as many times as desired continuing to defer the capital gains tax.

Three Easy Steps to Determine Capital Gains

Adjusted Basis is determined by

Original Purchase Price

Plus Improvements

Less Depreciation

Realized Gain is determined by

Sales Price

Less Adjusted Basis

Less Selling Expenses

Taxes Due are determined by

Recaptured Depreciation:  Multiply the depreciation taken by 25%.

Federal Capital Gains:  Subtract the depreciation taken from the realized gain.  Then multiply the remainder by the capital gain rate for short term rate or ordinary income rate if asset is held for less than one year and a day.  If longer multiply the remainder by the long term rate or currently 15% as of November, 2010.

State Capital Gains:  In Indiana, the state capital gains rate is applied to the entire realized gain.  Each state may determine their gains differently.

Add the three numbers together and the total represents what is deferred in a 1031 exchange.  Some states do not impose a state capital gains tax, consequently, add the two numbers to determine the tax that can be deferred.

What is Capital Gains

Capitals gains is the tax on the investment income or profit earned from holding or owning real or personal property.  Capital gain is triggered when the asset is sold resulting in a tax obligation if as determined above a capital gain exists.  Recaptured depreciation is determined by taking the total amount of depreciation itemized on federal income tax returns multiplied by 25%.

To learn more exchange tips, download a free guide that also includes

  • FOUR Exchange Rules
  • What is and is not eligible for a 1031 exchange
  • Identification Rules

1031 Exchanges in a Tight Credit Market

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What happens to a 1031 exchange when the ability to secure a loan is restricted?  There is only one real option.  That is to infuse additional cash into the exchange.  Additional cash offsets debt, but debt does not offset cash.  Once the replacement property is purchased, establish an equity line of credit to pull out cash without triggering a tax also known as a post exchange refinance.

Reverse Exchange

Tough credit markets require additional planning.  Perhaps the replacement property should be acquired through a 1031 reverse exchange.  By purchasing the replacement property before selling the old or relinquished property, the outcome of tight credit will be mitigated rather than the alternative of a failed exchange because either the loan process exceeded the 180 calendar day time requirements or addtional cash was not available.

Installment Note

Another possible option is an installment loan, where the Exchangor carries the paper for the Buyer of their property.  The key is to convert the note into cash to use towards the purchase of the replacement property.  These are fairly rare and are accomplished by once again the infusion of additional cash to purchase the note from the Qualified Intermediary.  The exchange proceeds as normal while the payments received from the buyer are no longer taxable in the year they are received.

Planning is the key to exploring the options before entering into the sales agreement for the old property.  When considering selling an investment property call us (850.496.0090 or andgus@atlas1031.com) to discuss your options.

Five Emerging 1031 Exchange Trends

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The last several years in the 1031 exchange industry have been to say the least challenging. Don’t get me wrong, I love doing what I get to do everyday. What is that? As a qualified intermediary, I help individuals and companies defer capital gains taxes through what is known as a 1031 exchange.

1031 Exchange Trends

Since late 2006, real estate prices for investment properties began to stall, slowly falling into free fall from 2007 through 2010. States effected the most were those that also saw the rapid appreciation of 25 to 30% for the period 2003 – 2005 such as Florida, Nevada and California. I saw first hand how condominiums and rentals properties along the Gulf Coast from Texas to Florida experienced the highs and lows of perceived value compounded by natural disasters of hurricanes and an oil spill. Today, I see the following trends in the 1031 exchange market:

  • all cash buyers both individuals and corporations;
  • a desire to diversify replacement property into oil and gas royalties as an alternative to real estate;
  • unallocated gold and silver bullion exchanged for the physical metal;
  • bonus depreciation for corporations has reduced the need for 1031 exchanges in like-kind exchange (LKE) programs;
  • more reverse 1031 exchanges than the traditional forward acquiring under valued properties in preparation for the current upward trending business cycle.

The Joint Committee on Taxation estimates a 21.88% increase in the value of tax deferrals from $2.5 billion in 2011 to $3.2 billion in 2012. This is up from $2.1 billion in 2010. The majority of those exchanges or 62.5% are estimated to be by corporations in 2012.

The individual exchange will be a slower to rebound given Revenue Procedure 2008-16 effective March 10, 2008 requiring vacation rental properties to be held for two years followed by the replacement rental property to also be held for two years to qualify for a 1031 exchange.

Conclusion

Unless the 1031 exchange is eliminated as a deficit reduction measure, the number and value of the tax expenditure is estimated to continue a slow rebound from the 2003 – 2005 era when the estimated value of tax deferrals reached $73.6 billion in 2004.

When considering whether a 1031 exchange makes sense, consider other reasons than just the tax deferral. If you are not sure, call us for a free consultation.

What You Get

  • Rapid response within 12 hours of request;
  • Thoroughness and expertise of a Certified Exchange Specialist®;
  • The value of your potential exchange;
  • The estimated recognized tax if an exchange is not initiated;
  • Email summarizing plan of action and details of consultation.

What You Don’t Get

  • A sales call;
  • Mumbo jumbo technical jargon;
  • Responses that are not compliant with the 1031 code.

New Hampshire SB 483 and 1031 Exchange

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Recently, the New Hampshire Governor signed Senate Bill 483 into state law. This is a significant event in the 1031 exchange world especially as states look for revenue generating sources.

“The new law amends prior law which would deprive taxpayers Section 1031 tax deferral on a state level if they purchased replacement property in the name of a new entity, notwithstanding that the acquiring entity was a disregarded entity. The typical situation would be that in which a taxpayer was required by a lender or TIC sponsor to acquire a replacement property in the name of a new single member LLC. The State of New Hampshire began disallowing exchange treatment on those transactions in 2008 and began to audit previously closed transactions as far back as 2004, without notice either to taxpayers or to the professionals in the industry.

The new law makes it clear that exchange treatment will not be affected by taking title in the new entity as long as the entity is a single member LLC, revocable trust or other entity which is disregarded for federal income tax purposes. The amendment eliminates the “claw back” efforts to 2004.” Provided by the Federation of Exchange Accommodators.

For New Hampshire the bill removes a tax liability that otherwise made 1031 reverse exchanges a non starter. Single member limited liability companies are frequently used to take title to either the new or old property in a reverse 1031 exchange.

What do you think about the New Hampshire state law?

How Lender Requirements Impact 1031 Exchanges

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The Lender requires only the wife’s husband on the replacement property loan because the wife owns too many investment properties. The wife wants to defer the capital gains on the sale through a 1031 exchange. Does this impact a 1031 exchange, if so how?

It depends:

1.  Is there debt on the old property?
a.  If there is debt is the wife adding additional cash to offset the debt in the purchase of the replacement property?

2.  If there is no debt, is 100% of the net equity or exchange proceeds from the old property sale being used towards the replacement property purchase?

Given the answer to either of these questions is yes, the wife is not receiving a benefit, consequently, a 1031 exchange makes sense.

The Lender is not requiring the husband to be on the replacement property title. He should be added to the title of the old property as far in advance of the sale as possible. Then the replacement property title would be in the name of the husband and wife. The husband’s loan would be used towards the purchase in addition to the wife’s 1031 exchange proceeds from the sale.

In this specific case, the wife owns the investment properties in a single member limited liability company (smllc) with the wife is the sole member. Rather than adding the husband as a member, add the husband as a tenant in common to the old property deed. The title would resemble name of smllc and her husband’s name with or without percentage of ownership.

Conclusion

If there is debt on the old or relinquished property and the husband’s loan is needed to purchase the property, then the wife will trigger mortgage boot or a tax on the debt she has not replaced. A 1031 exchange may not make sense. If no exchange, then she would pay the capital gain tax on the old property sale and purchase the new property without the 1031 exchange requirements with the help of her husband’s loan.

 

New Hampshire SB 483 and 1031 Exchange

Posted on | by Tom Gustafson | Leave a Comment on New Hampshire SB 483 and 1031 Exchange

Recently, the New Hampshire Governor signed Senate Bill 483 into state law. This is a significant event in the 1031 exchange world especially as states look for revenue generating sources.

“The new law amends prior law which would deprive taxpayers Section 1031 tax deferral on a state level if they purchased replacement property in the name of a new entity, notwithstanding that the acquiring entity was a disregarded entity. The typical situation would be that in which a taxpayer was required by a lender or TIC sponsor to acquire a replacement property in the name of a new single member LLC. The State of New Hampshire began disallowing exchange treatment on those transactions in 2008 and began to audit previously closed transactions as far back as 2004, without notice either to taxpayers or to the professionals in the industry.

The new law makes it clear that exchange treatment will not be affected by taking title in the new entity as long as the entity is a single member LLC, revocable trust or other entity which is disregarded for federal income tax purposes. The amendment eliminates the “claw back” efforts to 2004.” Provided by the Federation of Exchange Accommodators.

For New Hampshire the bill removes a tax liability that otherwise made 1031 reverse exchanges a non starter. Single member limited liability companies are frequently used to take title to either the new or old property in a reverse 1031 exchange.

What do you think about the New Hampshire state law?