Am I calculating this correctly?
Your numbers look good, except your 20% capital gain tax would only be about $79k (20% x the portion of the capital gain not attributable to depreciation recapture).
Are we really facing somewhere around $100k in taxes if we don’t do the 1031?
But yes, all in all, you'd be looking at over $100k in taxes at the federal level alone assuming those values are all correct. (Don't forget state taxes.)
What type of property (numbers wise) do we need to be considering in order to avoid paying capital gains?
If you want all gain deferred, you must meet two criteria in terms of the property acquired.
The first criteria is that the value of the replacement property (or properties) have to exceed or equal your net sales price, which in your example would be $535k ($575k - $40k).
The second criteria is that you must reinvest all of your net proceeds after mortgage. I couldn't give you a number here since I'm not sure if your property had a mortgage and if so how much.
Can we buy 2 properties or does it have to be 1?
You can exchange into multiple properties, though there are additional rules if you want to identify more than three as potential replacement properties.
Does that delay all of the tax due (Depr recapture & cap gains)?
Yes, the 1031 exchange has the potential to defer all taxes, both depreciation recapture and the other capital gains.
What happens when we sell the next property? Do the gains (tax owed) from Prop A keep carrying forward to subsequent properties as long as we follow the rules & invest up?
Yes, if you keep on doing 1031 exchanges, and Congress doesn't kill the provision, you can potentially defer all taxes indefinitely.
How do we make sure we do all of the steps in the right order at the right time? Is that where the intermediary comes in or is that our realtor’s job?
The intermediary will hopefully educate you on the 1031 sequence, but the realtor of course can't be asleep at the wheel when it comes to identifying potential replacement properties and ensuring they close within the appropriate timeframe.
We also have another property with similar numbers. Would it be beneficial for us to consider doing the same with that property?
Sure, if you've already made the business decision to sell it and acquire a new property (this decision should be made first apart from any tax implications).
Is there any tax benefit/downside to holding a rental that is fully depreciated?
Well, you no longer get the depreciation deduction.
Keep in mind that in a 1031 exchange the basis from the relinquished property (or properties), called the "exchanged basis," carries forward to the replacement property (or properties). It's not like you get to reset depreciation on that piece.
However, if you have additional basis in the replacement property (or properties), called the "excess basis" (say you put more cash into the deal), then that piece would generally get a fresh start depreciation schedule.
Thank you for reading that mess of a post and replying. I had it all nicely formatted and the app crashed when I hit send. I assumed I would have to rewrite it this morning.
There is currently a 200k mortgage.
@Michele G. , Logan pretty much nailed it for you. To emphasize a couple of things. You'll be best served to focus on reinvestment criteria and timing.
As Logan pointed out if you want to defer all tax you need to purchase at least as much as your net sale and use all of the proceeds. But the number and type of investment real estate does not matter. Selling one and buying multiple properties in a 1031 is simply a function of matching aggregate values (and some rigid identification rules).
Selling 2 and buying one larger piece of investment real estate is the same thing with one added component. In addition to purchasing enough investment real estate to cover both sales, you also have to watch the calendar. Unless the two properties are sold as one portfolio on one contract they will actually be two 1031 exchanges - each with their own calendar and reinvestment requirements. You'll need to adhere to the dates of the first sale since that is the exchange that will expire first if you want to combine the two sales.
You also mentioned the benefit of holding a full depreciated asset for rent. The 1031 can address that as well since every dollar you purchase in a 1031 more than you sold adds a dollar of new depreciable basis. If you sell a property with $20K land basis only for $320K you can replace that with a $600K purchase and gain $300K of new depreciable basis. So the clock doesn't reset with a 1031 but you can start a new clock.
The rules for doing a 1031 are quite specific but there's also a lot of flexibility to help you achieve your strategic goals. The key is planning early and working closely with your professionals the QI being one of them.
Thanks @Dave Foster I think we will try to do one at a time for our first exchange. Are there any limits in regards to the 1031 if we change the ownership structure on the deed of the property now before we sell the property? I am aware of the Due on Sale clause.
@Michele G. , yes there's some pretty clear guidance from case law that changing the tax payer (owner) of a property right before sale puts your 1031 in jeopardy. The primary reason for that is that the intent of the exchanger in owning the property must be to hold the property as investment. Changing the owner right before sale puts the intent of the new owner in question. Any kind of change like that before the exchange opens you up to all kinds of scrutiny for basis shifting and improperly avoiding gain. Not a good idea.
It is far more advisable to complete the 1031 and then create whatever asset protection or entity structure you want for the property - after the fact. This is usually better for lenders as well since you can negotiate with them up front about the loan in your name and quit claiming the property into another entity after taking title.
Great info @Dave Foster
Thank you @Dave Foster If I understand you correctly once the sale is finalized the IRS is ok with the new property ownership changing (we would be moving it from my personal name into an LLC with me and my husband as members). I assume the deferred gains would transfer to the new ownership structure. Our hurdle would be to make sure the lender will allow us to transfer the deed post sale.
@Michele G. , That's right, the lender is probably your biggest hurdle. But they'd be a hurdle if trying to buy in an unseasoned LLC anyway.
The key is to make the contribution into the LLC so as not to trigger a recognition of gain. In your case it sounds like you're wanting to form a single member LLC (you and your husband or actually your joint return as the tax payer) that will be taxed as a sole proprietor. In that event the activity of the property will still be reported on your Schedule E so nothing will change from a tax reporting perspective and in the eyes of the IRS the taxpayer hasn't changed either - just the name on deed.
Am I understanding you guys right as far as the depreciation portion of the puzzle?
The way I am understanding : I have a property that I bought for 100K and it is fully depreciated, but has appreciated in value to 200K. I know sell that one and do a 1031 into a new property.
If the new property that is only 200K in price, I *wont* get to take any more depreciation since I 'used it up' in the first property. But if I buy a new property for 400K, I would now have 200K of 'new basis' that I could depreciate? If that is accurate, is that 'new basis' done over the full 27.5 years just like normal?
Thanks for all the knowledge you guys share here on BP too!
Yep @Dave Foster the depreciation schedule on the excess will still be 27.5 year for residential rental property and 39 year for non-residential commercial property.
I have been involved with a number of 1031's with other investors. I recommend you find a reputable company that only does exchanges and follow what they say to the letter. On paper it all sounds great, but it is a HUGE pain and there are a million things that can go wrong and disqualify the exchange.
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