Section 1031 of the tax code has fallen out of favor in the past few years, but with the introduction of a new higher capital gains rate, and an extra 3.8% tax to pay for Obamacare on “investment income” over $250,000.00, the costs for selling highly appreciated property have increased more than 50% over 2012 rates. This means that the long term strategy of paying the capital gains tax rates when they were at a low 15% is not always the best strategy now. This is where the 1031 tax deferred exchange can come into play.
The basic premise of the 1031 exchange is that the tax on capital gains can be deferred by purchasing a different property with the funds from the sale of the highly appreciated property. This process would let you save the extra tax that you could capture at a later time, either when tax rates are lower, or in a year where you did not have the 3.8% surcharge, meaning you can now control your taxes with even greater efficiency.
Take a basic example of selling a parcel of land in which you have a $50,000.00 basis, but you are selling it for $150,000.00, meaning that if you sell it, you will have capital gains on $100,000.00 at 20%. An even greater risk is if you have $250,000.00 in “investment income,” you would also pay an extra 3.8% on the $100,000.00. In this case, your taxes would be $23,800.00 of the total $150,000.00 sale.
Now, with the 1031, you could re-invest all $150,000.00 into another property, and that $23,800.00 in taxes would not be owed now, but it would carry over into the basis of your new property. So only when you sell the purchased property would you need to actually recognize any gains and pay tax.
Important to know is that you cannot ever take possession of the funds from the property sold. You need a qualified intermediary, such as the Story Law Firm, PLLC, to act as your intermediary, meaning that the funds from the sale would be deposited into our trust account and then used for the purchase of the new property.
Before you sign a sales contract, please call one of our Arkansas 1031 Property Attorneys for help in organizing the transaction.