Federal and state capital gains taxes are triggered when selling real and personal property held in the productive use of a business or for investment. Even if the asset does not appreciate, there is a depreciation recapture tax of twenty five percent on the aggregate depreciation taken or that could have been taken. The taxes can represent upwards of forty percent of the asset sale. Given the intent is to replace the asset with another, consider initiating a 1031 exchange to use those tax dollars as additional, interest free working capital to acquire the new property rather than paying the taxes.
2013 Capital Gains Taxes
Effective January 1, 2013, the federal capital long term rate for real and personal property increased from 15 percent to 23.8 percent for non-collectible assets. The rate increase along with an improving real estate market, has renewed interest in the 1031 exchange. Determining the taxpayer’s modified adjusted income and corresponding federal and state capital gain rates should be the first step towards understanding to whether a 1031 exchange makes sense. Review the following chart to acquaint yourself with the new rates.
Collectibles such as vintage cars, gold and silver bullion and artwork, are taxed at 28 percent plus state capital gains rates.
Seek the input of your CPA to confirm the tax consequences. They will know whether there are other factors relative to your federal return that could offset the gain and tax.
Qualified Intermediary
Before listing your property for sale, talk with a Qualified Intermediary, or QI. Describe the transaction, including anticipated sales price and whether or not there is debt on the property. Ask the QI to walk through how a 1031 exchange works, the rules and their role. Each exchange is similar to a puzzle with each piece corresponding to a 1031 exchange rule. Understanding and complying with those rules is critically important to the success of your exchange. Knowing what questions to ask a QI is summarized in the following single page eGuide. Nine states have legislated state laws requiring the QI to follow certain procedures or face civil and criminal penalties. Those states include Washington, Oregon, California, Idaho, Nevada, Colorado, Virginia, Connecticut and Maine.
The QI industry is not regulated; consequently, anyone can offer the service. The Certified Exchange Specialist® (CES) designation is awarded to individuals who have provided 1031 exchange consultations for three years, passed the board level exam and who receive twenty hours of continuing education every two years. The CES designate also follows a strict Code of Ethics. The CES designation does not prevent the QI from being dishonest but improves the probability the QI is trustworthy and knowledgeable.
1031 Interdependent Steps
A 1031 exchange is a series of interdependent steps that defers the federal and state capital gains taxes. Section 1.1031 of the Internal Revenue Code states that no loss or gain is recognized when property held for productive use in trade, business or for investment is exchanged solely for like-kind property productively held in a trade, business or for investment. Real property can be exchanged for any real property while personal property must be exchanged for like-kind or like-class personal property.
The taxpayer enters into a Purchase and Sale Agreement or Bill of Sale for the relinquished or old property. Title is transferred to the Buyer and the net equity from the sale is deposited into an escrow account under the taxpayer’s tax identification number. Following the closing, the replacement property must be identified, preferably to the QI, no later than 11:59 PM on the 45th calendar day with the replacement property acquired no later than the 180th calendar day. Given the net equity and retired debt, if any is equal to or greater in the replacement property, then the gain has been deferred.
If you would like to review your transaction with a CES, please click on the button below and ask the CES to contact you.
