In 2013, the capital gains tax rate increased for those in the upper income brackets. Internal Revenue Code Section 1031 and Treasury Regulations provides a welcome relief for those taxpayers who replace their assets by potentially indefinitely deferring the federal and state capital gain by engaging a Qualified Intermediary to accommodate a 1031 exchange.
With the American Taxpayer Relief Act, the capital gain tax rate was increased to about 20% for both individual and married couple taxpayers. The capital gains tax rate goes up even higher when you look at the Medicare surtax on net investment income. Wealthy taxpayers could see their capital gains tax rate rise over more than half their previous rates.
Investors owe capital gain taxes on their economic gain according to their income while businesses are also assessed capital gain taxes. Investment or personal property used in a business like aircraft, kidney dialysis machines, oil and gas, heavy road construction equipment sold triggers a 25% tax known as recapture depreciation. Taxpayers should also look at the applicable state, county and municipal capital gain taxes in addition to the federal capital gain taxes.
Potential Economic Impact
Many people share the opinion that long term capital gain taxes are detrimental to economic growth. Capital gains are taxed when the asset is sold. When capital income is taxed, the reward for investing in equipment or for appreciation is diminished providing a disincentive to invest in capital assets. The outcome of higher capital gains tax rates is potentially less investment, fewer jobs, lower wages and a deflationary economy.
With the capital gains tax rate going up, there are those taxpayers and businesses who will delay replacing equipment to maximize utilization and possibly not replace given with higher taxes, there is less capital to reinvest. Why invest to pay a higher tax rather, hold as Treasury bills or Certificate of Deposits avoiding the higher capital gains tax rate.
To the contrary, there are advocates who suggest that there isn’t a lot of capital gains tax collected, so there isn’t a lot of damage done; however, the majority of analysts believe that a higher capital gains tax causes a lack of hiring, minimal economic expansion reducing gross domestic product growth. When the capital gains tax rate is lower, the return on capital is higher, providing an incentive for investment activity.
The consensus is that a high capital gains tax rate hurts the poor and society in general because it limits economic expansion. Capital gains taxes are a controversial topic especially for the taxpayers and businesses dependent upon capital assets as a revenue generator.
1031 Tax Deferred Exchange
An effective strategy to minimize higher capital gains is to replace the asset in a 1031 exchange. The outcome is that now the taxpayer has an asset with a longer useful life, depreciation that offsets income and interest free operating capital that would otherwise be paid out in taxes. The tax deferred dollars are fully utilized by being invested in assets that are aligned with business strategies to maximize investment return.
1031 Exchange Examples
An example is a road construction company that sells their Roadtec milling machine and replaces with a newer more efficient model. Another example is an Original Equipment Manufacturer of agricultural equipment that owns a business aircraft for reasons to reduce travel expenses and flexibility. By exchanging for a more efficient, bank owned aircraft, their cost of business is reduced. Capital gain tax rates impacts every part of our US economy from our competitiveness in the world market to research and development.
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