Our government believes in a sharing economy. When you sell an asset that has been held for investment, say either stocks or real estate, both the federal and state treasuries want a share of your profit as the capital gains tax due at time of sale.
The current federal capital gains tax rate is 15 percent. The state of California adds another 9 percent plus, bringing the total capital gains tax rate in our golden state to approximately 25 to 33 percent, one of the highest in the nation.
There is a way to defer taxes owed on the sale of investment real estate as long as you keep the profits in play. IRC Section 1031 provides an exception that allows you to postpone paying tax on gain if you reinvest the proceeds in similar property as part of a Like-Kind Exchange, commonly known as a 1031 Tax Exchange. The rules are many with transaction time frames that must be strictly followed but it is well worth the effort.
Adeferred exchange is the most common 1031 Tax Exchange. Upon the sale of one property, an exchange escrow is opened with a qualified intermediary who will execute the agreements according to IRS rules.
Within 45 days from the closing of the relinquished property, you must identify the purchase of another replacement property of like kind, and close within 180 days. All of the net proceeds must be reinvested into a replacement property of greater value or you could be subject to taxable “boot.”
You can also structure a reverse exchange where you acquire the replacement property first, then have 45 days to identify the relinquished property and complete the sale within the 180 day timeline. These types of exchanges are highly technical and consultation with your accountant or tax attorney is advised.
Like-kind property is defined to be of similar nature, character or class. Most real estate will be like kind and a rental house may be exchanged for vacant land or units. The property can be anywhere within the United States. Before you sell that piece of investment property whose location or function is no longer desirable or working for you, think about exchanging it for another more suitable property before you take the hit in taxes.
Of course gain is deferred but not forgiven in a like-kind exchange. Your tax professional will calculate and keep track of your basis in the new property so that if and when it is ultimately sold the tax man will be paid.
Adriana Donofrio Podley Properties Glendora 626 926-9700 • adrianad@podley.com
