To 1031 Exchange or Not to 1031 Exchange Tax Question

6 Replies

I wanted open this questions to @Brandon Hall or other BP investors who have experience with 1031 exchange.

Suppose that i have a property in Chicago that i purchased for $400,000. Over the years, I have taken a depreciation to offset my income on schedule E of $25,000.  I sell this home for the same price I purchased it, I would then have a basis of $375,000. I would guess that I would then have a tax liability of $3750 (25,000 * .15 capital gains tax). Let's say that after my closing costs, fees, and mortgage I net $100,000 from the sale of my Chicago. 

Here are my questions:

1) If I reside in GA, will I have any tax implications with the state of IL?   

2) If i identify a investment property in GA and I use the entire $100,000 proceeds from my Chicago property and additional funds to buy the property with cash, would this be a transaction I can defer my taxes.

3) With a small capital gains tax of $3750, would a 1031 exchange be advisable?

One important information I would like to add is that this was a primary residence that turned in a rent in the summer of 2011.

Thanks.

James

Originally posted by @James Park:

Suppose that i have a property in Chicago that i purchased for $400,000. Over the years, I have taken a depreciation to offset my income on schedule E of $25,000.  I sell this home for the same price I purchased it, I would then have a basis of $375,000. I would guess that I would then have a tax liability of $3750 (25,000 * .15 capital gains tax). Let's say that after my closing costs, fees, and mortgage I net $100,000 from the sale of my Chicago. 

The depreciation recapture is generally taxed at 25%. 

Here are my questions:

1) If I reside in GA, will I have any tax implications with the state of IL?   

2) If i identify a investment property in GA and I use the entire $100,000 proceeds from my Chicago property and additional funds to buy the property with cash, would this be a transaction I can defer my taxes.

Yes, as long as you trade equal or up in value based upon your net sale price and you have reinvested all of your net cash proceeds (equity) you will defer all of your taxes.  You will not defer any of your taxes if you only reinvest in your cash proceeds. 

3) With a small capital gains tax of $3750, would a 1031 exchange be advisable?

Financially, yes, exchange fees are generally around $800, so you would defer $5,000 for an $800 fee.  You would have to decide if meeting the exchange requirements is worth it if you are deferring about $4,200 in taxes. 

Originally posted by @James Park:

I wanted open this questions to @Brandon Hall or other BP investors who have experience with 1031 exchange.

Suppose that i have a property in Chicago that i purchased for $400,000. Over the years, I have taken a depreciation to offset my income on schedule E of $25,000.  I sell this home for the same price I purchased it, I would then have a basis of $375,000. I would guess that I would then have a tax liability of $3750 (25,000 * .15 capital gains tax). Let's say that after my closing costs, fees, and mortgage I net $100,000 from the sale of my Chicago. 

Here are my questions:

1) If I reside in GA, will I have any tax implications with the state of IL?   

2) If i identify a investment property in GA and I use the entire $100,000 proceeds from my Chicago property and additional funds to buy the property with cash, would this be a transaction I can defer my taxes.

3) With a small capital gains tax of $3750, would a 1031 exchange be advisable?

One important information I would like to add is that this was a primary residence that turned in a rent in the summer of 2011.

Thanks.

James

1. Yes, IL will tax you on the capital gain unless you 1031; however, there can be implications if you 1031 to another state.

2. That will depend.

3. What was your basis in the property before it was converted.

Steve,

I understand that if the home was used prior as your primary residence in the last 5 years you are tax exempt on any capital gains up to $500,000 if filed jointly. The part I am unsure of is if you would get the primary residence tax exemption if you have taken depreciation on the home during the time you held it as a rental. Will you will be tax exempt from your sale price - cost basis?

Here is a scenario:

Bob and his wife lived in a home as a their primary residence in TN from 2005 -2012. They converted their primary residence into a rental from June of 2012 and started to take depreciation on the home 1/2 the year from 2015.

If they purchased the home in 2005 for $300,000 and took a depreciation of $20,000, their basis on the property is now $280,000. Bob, sells his property to his tenant for $320,000. Will Bob be tax exempt from the sale price of $320,000 - basis cost of $280,000 since this home was used as their primary residence from 2005 - 2012, within the last 5 years?

I am starting to understand the tax implications of depreciation on my real estate investments. I am now changing my strategy to plan to hold onto my Atlanta real estate investments for 20+ years, otherwise to 1031 exchange to better, newer, and profitable investments. The depreciation the IRS gives you to off set your income on schedule E is not free money, but an amount that you will eventually have to  pay back once you sell your property, unless you 1031 exchange. If you own a $500,000 rental property and hold it for 27.5 years until you can no longer depreciate the home and sell the home for a million dollars. You would basically have to pay capital gains tax on that entire 1,000,000. Now, that is some serious coin.

@James Park Thanks for the shout out. It seems Bill and Steven have already answered the majority of your questions. The thing I would add is to make sure you nail down your adjusted basis as that will allow you to calculate your tax liability. 

In your example, as long as it has not been longer than three years since Bob converted his primary residence into a rental, he can still qualify for the section 121 capital gains exclusion. 

@Brandon Hall

Thank you for your reply. 

I did find the IRS publication on my question.

Determine whether you meet the residence requirement. If your home was your residence for at least 24 of the months you owned the home during the 5 years leading up to the date of sale, you meet the residence requirement. The 24 months of residence can fall anywhere within the 5-year period. It doesn't even have to be a single block of time. All you need is a total of 24 months (730 days) of residence during the 5-year period.

http://www.irs.gov/publications/p523/ar02.html

Originally posted by @James Park:

Steve,

I understand that if the home was used prior as your primary residence in the last 5 years you are tax exempt on any capital gains up to $500,000 if filed jointly. The part I am unsure of is if you would get the primary residence tax exemption if you have taken depreciation on the home during the time you held it as a rental. Will you will be tax exempt from your sale price - cost basis?

Steve and Brandon are right on the money.  Taxpayers have a three (3) year window as soon as they move out of their primary residence and convert it to rental or investment property in order to take advantage of the 121 Exclusion ($250K/$500K tax-free exclusion under Section 121 of the Internal Revenue Code).  They must decide to sell and close on the sale of their former primary residence no later than the last day of the three (3) year window if they want to take advantage of the exclusion.

Depreciation recapture can not be excluded under Section 121, so any depreciation taken would still be recaptured.  Properties that are not sold during the three (3) year window become solely investment properties and no longer qualify for the tax-free exclusion.