Tax Due when selling part of 1031 Exchanged Property

8 Replies

Hi BP'ers and Pros,

I am considering buying multiple SFRs in a 1031 Exchange of my Tri-plex.

Obviously, this will defer any taxes, capital gains etc.

So for a simple example, I will buy 4 x 250K = $1M in a 1031 Exchange.

Let's say my total tax burden would have been 300K.

So, if in the future I decide to sell one of the 4 houses that were part of a 1031 exchange

at say 250K ( same price ) then would I pay a prorated capital gains tax of  75K ( 1/4 of 300K ) or would then entire tax on $1M become due ?

Thanks, R

Originally posted by @Richard Chang :

In your theoretical example, you would have a new adjusted basis for each property.  If you sold one of them in the future, you would pay taxes on just that portion of profit.  Remember that on a depreciated property, you would have recapture rates (25%) apply on the depreciated portion of the profits.

Mark

@Mark Creason

Thanks Mark,

Good point remembering about the Depreciation Recapture.

So, if the depreciated amount were 200K on the property in a $1M Exchange, then

prorated depreciation would be 50K for each of the 4 houses with same 250K price ( tax to be paid at 25% ).

Thus, 25% of 50K would be $12.5K more tax minimum ( not included state taxes ).

I figure that it may be an option with SFRs when you need cash to sell one of the properties.

Best, R

Hi,

The other scenario would be to sell 1 house and then buy another >= 250K price in another 1031 Exchange.

In this situation, I believe there would be no tax due.

Hopefully, @Bill Exeter can comment

Thanks, R

@Richard Chang it depends on how you allocate the basis of the 1031. For instance, unless you are buying 4 identical houses, you will likely not maintain the exact same basis in each. There are a variety of methods and valuation models to use when allocating basis. 

But, let's assume the houses are identical and we are using your numbers. We have a built in capital gain of $75k and depreciation recapture of $50k. The capital gain is taxed at 15% unless you are are in the 39.6% bracket or have a lot of deductions placing you in the 10% or 15% tax bracket. Capital gain tax = $11,250.

Section 1250 recapture (depreciation recapture) is taxed at a minimum 25% rate. Section 1250 recapture = $12,500.

Total Tax = $23,750.

If you qualify for the Net Investment Income Tax, you will enjoy an additional 3.8% tax on your net investment income exceeding thresholds depending on your filing status. 

You will also have applicable state taxes to pay. 

There are plenty of tax deferral strategies out there. I'd recommend connecting with a real estate CPA and see what they have to say. 

@Brandon Hall   @Mark Creason

Thanks for your help in clarifying this. 

My question is how the basis for each of the 4 properties is determined in the 1031 Exchange.

To simplify the math,  the original basis is 500K and Sale is > $1M with a net of $1M after costs of sale then the capital gain would be 500K assuming there is no capital improvements.

If each replacement property is 250K then the basis would be evenly divided with  500K/4 = 125K each.

Selling a 250K for the same price

250K - 125K basis = 125K capital gain  

Fed Tax 125K * 15% 

Depr recapture 125K * 25K

But if the new properties have different prices: 100K 200K 300K 400K totaling 1M then wouldn't the basis' be proportionally calculated:

10% * 500k orig basis = 50K basis

20% * 500K = 100K basis

30% * 500K = 150K basis

40% * 500K = 200K basis

Likewise the sale of a property would trigger additional depreciation recapture tax rate at 25% of the proportional amount

10% * 200k = 20K 

20% * 200K = 40K 

30% * 200K = 60K 

40% * 200K = 80K 

So, if I sold the 300K house for 300K then the 

Fed Tax @15% would be

300K sale -  200K basis   = 100K capital gain  * 15% = 15K Fed Tax

80K Deprec Recapture * 25% =  20K

Total Tax 15K + 20K = 35K

Gross Profit = 100K - 35K = 65K  before State Taxes

Thanks, R

@Richard Chang   Like @Brandon Hall said your accountant will set up new depreciation schedules for the properties based on the adjusted cost basis of the relinquished property as it relates to the exact replacement cost of each new property (keep in mind that non-depreciable property such as land or the attached lot to one of those properties can also throw a monkey wrench in your calcs).  And there are several methods to do that.  Proportional allocation to purchase price is one of those ways.  Then if you have need to sell one without a 1031  the calc for depreciation recapture will be straightforward. 

But hopefully you'll have many discussions with your acct, QI and advisors as you go since eventually paying tax once started on the 1031 path doesn't have to be a given.

Richard,

I believe that if you sold into 4 different priced properties as part of a 1031 exchange, that you would have a 150k basis moving forward on your 300k property.  If you sold it for 300k, without an additional exchange, you would have depreciation recapture at 25% on your 150k.  I would think your tax would be 37,500.  Just my opinion.

Mark

Originally posted by @Richard Chang :

@Brandon Hall   @Mark Creason

Thanks for your help in clarifying this. 

My question is how the basis for each of the 4 properties is determined in the 1031 Exchange.

To simplify the math,  the original basis is 500K and Sale is > $1M with a net of $1M after costs of sale then the capital gain would be 500K assuming there is no capital improvements.

If each replacement property is 250K then the basis would be evenly divided with  500K/4 = 125K each.

Selling a 250K for the same price

250K - 125K basis = 125K capital gain  

Fed Tax 125K * 15% 

Depr recapture 125K * 25K

But if the new properties have different prices: 100K 200K 300K 400K totaling 1M then wouldn't the basis' be proportionally calculated:

10% * 500k orig basis = 50K basis

20% * 500K = 100K basis

30% * 500K = 150K basis

40% * 500K = 200K basis

Likewise the sale of a property would trigger additional depreciation recapture tax rate at 25% of the proportional amount

10% * 200k = 20K 

20% * 200K = 40K 

30% * 200K = 60K 

40% * 200K = 80K 

So, if I sold the 300K house for 300K then the 

Fed Tax @15% would be

300K sale -  200K basis   = 100K capital gain  * 15% = 15K Fed Tax

80K Deprec Recapture * 25% =  20K

Total Tax 15K + 20K = 35K

Gross Profit = 100K - 35K = 65K  before State Taxes

Thanks, R

 I'm going to be honest and I'm sure both gentlemen here will agree with me there is too much liability about giving a direct number answer on a forum without engaging someone as a client. We dont know your whole situation and are not about to make guesses. 

This is the point where you contact an accountant for advice and tax planning if they don't charge for their services... RUN.