Prices in many areas have regained their pre-financial-crisis levels. Prices in a few areas have surpassed those levels and ‘re going up still. That means many real estate investors now own properties that are worth way more than their tax basis. That’s especially likely with accommodations property that you’ve claimed depreciation deductions over the years.
Those depreciation write-offs reduced your taxes basis in the house, producing a bigger taxable gain if you sell. Here’s the message: If you’re a well-seasoned person that is the owner of real property that would trigger a large taxable gain if sold, please think long and hard about not offering. Because simple inaction, or arranging for a tax-free Section 1031 exchange, instead of a sale, could be tax-smart strategies.
This column clarifies why, after first covering some necessary history information. If you sell a greatly-appreciated property, you will probably pay the maximum 20% federal government long-term capital increases rate on your whopping big profit. If we are discussing a rental property, you will probably pay a 25% federal government rate on the part of the gain that’s due to depreciation write-offs. You’ll probably owe the dreaded 3.8% net investment tax too. If you reside in a continuing state with a personal income tax, you can pile that taxes rate on top of what you’ll owe the Feds. When you add up all the rates, the full total could be an unacceptably high percentage of the sale price (see below).
The simplest tax-saving strategy in the greatly-appreciated real property situation is to do nothing at all. Hang onto the property. Don’t sell it. Here’s why. If you’re unmarried, the foundation step-up rule pertains to your entire ownership fascination with the house. So whenever your heirs sell the property, federal capital benefits taxes are only going to be due on the excess gratitude (if any) occurring after the magic day.
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- US Sprint Corporation (83%)
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- The companies are highly cashflow generative
If you are wedded and your spouse own the property together, the tax basis of the portion you possess is stepped up when you die. The basis of the remaining portion is stepped up whenever your spouse dies. Once again, your heirs will most likely owe little or nothing to Uncle Sam when the property is sold. If the taxpayer-friendly basis step-up deal is available under applicable state income tax rules also, the hang-onto-the-property strategy works the same tax-saving magic for state income tax purposes.
You may love the idea of avoiding fees on your greatly-appreciated investment real property, but you should unload your current property and reinvest in other property that you think has more prospect of future appreciation. In that case, consider performing a tax-free Section 1031 exchange. You swap your current property for replacement unit property that you think has more upside.
With proper planning and focus on detail, the Section 1031 exchange guidelines enable you to avoid most or every one of the tax strike from unloading the current property. The untaxed gain from the existing property reduces your taxes basis in the substitute property. So you start off with a built-in tax gain on the replacement property.
But if you hold that property before the bitter end, the aforementioned basis step-up rule could work its tax-saving magic for your heirs. 25% federal government rates on long-term gain due to depreciation deductions claimed for accommodations property. 20% federal government rates on the remainder of long-term local rental property gain or long-term land-sale gain.
3.8% federal government net investment income-tax rates. State tax rate, if applicable. Doing there is nothing not usually a good tax planning strategy, however the greatly-appreciated real property scenario is an exemption – if you keep hold of the house until death. The other tax-saving strategy is to set up a tax-free Section 1031 exchange, and then keep hold of the alternative property until you depart. If you are interested in the Section 1031 exchange idea, consult an expert who handles these deals frequently. Section 1031 exchanges aren’t good DIY tasks, but the tax cost savings can be huge.