A 1031 exchange represents a solid strategy for deferring the capital gains and recaptured depreciation taxes when selling and replacing like-kind, real and personal property held for productive use in a trade, business or for investment. These tax deferrals, along with asset liquidity, are the core benefits of the 1031 exchange.
The 1031 exchange is, in its own right, a subsidy from all US federal and state taxpayers to purchase real and personal property for use in a business or for investment. The tax deferral incentivizes businesses that lease equipment, aircraft, cars, trucks and technology to replace their inventory with newer models. The Treasury Regulation permits the owner of artwork, vintage cars, musical instruments, livestock and precious metals or timberland and commercial Real Estate Investment Trusts (REITs) to shift their investment portfolios, exchanging a less productive property for another more desirable one. Individuals and partnerships use 1031 exchanges to sell and replace real estate, whether the asset is a farm, ranch, vacation condominium, apartment or commercial property, for reasons of cash flow, depreciation, consolidation, diversification or relocation. Without the 1031 exchange, which represented an estimated revenue loss of $3.2 billion and $3.7 billion to the federal government in 2012 and 2013 respectively, fewer property transactions would occur, reducing if not eliminating thousands of ancillary businesses related to the above referenced markets. Many of those markets would experience a deep freeze, where the taxpayer would pass on the assets to their beneficiaries upon death.
Capital Gains Tax
There is merit to paying the federal and state capital gains and recaptured depreciation taxes, especially if the taxpayer wishes to cash out and not acquire replacement property. The federal capital gains rate is at a historical low. Why assume the risk that the replacement property will appreciate or the federal capital gains rate will be higher in the future? What’s more, the taxpayer may no longer wish to bear the benefits and burdens of property ownership.
Currently, if the individual taxpayer is in the 10 or 15 percent tax bracket, the federal long term capital gains rate is 0. For those taxpayers in the 25 percent or up brackets, the federal long term capital gains rate is 15 percent. The 15 percent is set to increase to 20 percent with another 3.8 percent for the Affordable Care Act for those earning $200,000 or more, for a total of 23.8 percent effective January 1, 2013.
On an asset sold in the year it was acquired, or held for less than one year from when it was purchased, the federal short term capital gains rate is taxed as ordinary income.
A 25 percent recaptured depreciation tax is assessed on the allowable depreciation, whether it is taken or not. Often in short sales and foreclosures, though there is not a tax on appreciation, the taxpayer is liable for taxes on depreciation.
If the net equity from the sale is not needed, a Deferred Sales Trust is an alternative to a 1031 exchange that does not require like-kind replacement property. The net equity from the sale is held in a Trust invested in marketable annuities and securities, allowing the earnings, principal or combination of the two to be paid out over a period determined by the taxpayer and their advisor.
To learn “Ten Reason Why a 1031 Makes Sense,” click here for a complimentary eBook. If you would like to ask questions, contact our office at 800.227.1031.
We Can Help
Atlas 1031 Exchange has been accommodating tax-deferred exchanges of all kinds for more than 17 years. We are fluent in the rules and regulations of IRC Section 1031 and able to help you navigate your exchange.
Contact us today to discuss any questions you may have. Call our office at 1-800-227-1031, email us at info@atlas1031.com, or submit your question through the online form at the top of this page.
