Set Aside for Taxes?

Question

Gang,

I have a rental property I am planning to sell.  I'm expecting to clear between $38k and $45k. I have owned it for over two years.  What percentage should I be setting aside for tax purposes?

Bill Exeter · Answer

Dan Shoemaker If you want to defer all of your taxes (capital gain, depreciation recapture and potentially the new Medicare Surcharge tax), you must acquire one or more properties that are equal to or greater in value than what you sold AND you must reinvest all of your cash proceeds/equity from the sale transaction.

You MUST have a Qualified Intermediary in place BEFORE you close on the sale transaction .  The QI will prepare the legal documents to properly structure your 1031 Exchange and hold your net proceeds/equity received during the 1031 Exchange.

Your 1031 Exchange funds can be used toward rehab costs as long as they are capital improvements.  This is referred to as a Build-To-Suit (Improvement) 1031 Exchange.  These are more complicated and expensive as the Qualified Intermediary must acquire and hold legal title to your replacement property and the rehab costs must be paid for and completed during your 180 calendar day exchange period.

Steven Hamilton II · Answer

20% should suffice; however, if you have an income over 200k, I'd start looking at holding 25% overall between recapture, capital gain and the Medicare surcharge.

Steven Hamilton II · Answer

Dan Shoemaker,

TO answer your question about the income level:  Under this provision, the 3.8 percent surtax applies to the lesser of NII or the amount by which a taxpayer's modified adjusted gross income (MAGI) exceeds $200,000 for single filers and $250,000 for joint filers. For example, a single filer with $150,000 in NII and a MAGI of $300,000 in 2013 must pay a surtax of $3,800 (3.8 percent of $100,000 exceeding the $200,000 MAGI level).

As far as a 1031 goes, Bill Exeter answered you perfectly.

A 1031 is what I'd be looking to do.

Dan Shoemaker · Answer

Steven Hamilton II, Jon offers an intriguing suggestion....

I will start researching this myself, but since I have the ear of an accountant... ;-)

Do I have to use ALL of the proceeds to purchase the rental property? Do I have to set those funds aside and/or leave them in escrow while I'm looking?  Can the funds be used for rehab on the next rental property? Is there anything else I should be considering?

Jon Klaus · Answer

If you intend to buy another rental property you might look into a Section 1031 exchange to defer the capital gains tax.

Dan Shoemaker · Answer

Thanks gents!

Jon Klaus, yes and no.  My plan is to use the proceeds to purchase more rental property OR to go into a rehab somewhere down the line.

Steven Hamilton II, would the $200k be combined income between my wife and I?

Jon Klaus · Answer

About 20% of your gain should be safe. You'll have to recapture a bit of depreciation, too. Are the proceeds going into a rehab/flip?

Set Aside for Taxes?

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