Prices in many real estate markets have regained their pre-financial-crisis levels. Prices in some areas have surpassed those levels and remain going up. That means many real estate investors now own properties that are worth way more than their tax basis. That’s especially likely with a rental 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 individual who is the owner of real property that could trigger a huge taxable gain if sold, please think long and hard about not selling. 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 long-term capital benefits rate on your whopping big profit. If we are talking about accommodations property, you will likely pay a 25% Federal government rate on the portion of the gain that’s attributable to depreciation write-offs. You’ll owe the dreaded 3 probably.8% net investment tax too. If you reside in a state with a personal income tax, you can pile that tax rate together with 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 scenario is to do nothing at all. Hang onto the property. Don’t sell it. Here’s why. If you are unmarried, the basis step-up rule applies to your entire ownership interest in the property. So when your heirs sell the house, the Federal capital increases taxes is only going to be credited on the additional appreciation (if any) occurring following the magic date.
- Great Lakes with 12.3 % development and a median price of $492,500
- US Sprint Corporation (83%)
- 3 Global Iris Scanner Biometrics Capacity, Production, Revenue (Value) by Region (2013-2018)
- The businesses are highly cashflow generative
If you are wedded as well as your spouse own the house together, the tax basis of the part you possess is stepped up when you perish. The foundation of the remaining part is stepped up whenever your spouse dies. Again Once, your heirs will probably owe little or nothing to THE GOVERNMENT when the house is sold. If the taxpayer-friendly basis step-up deal is available under applicable state tax rules also, the hang-onto-the-property strategy works the same tax-saving magic for state income tax purposes.
You may love the thought of avoiding taxes on your greatly-appreciated investment real estate, but you might want to unload your present property and reinvest in other property that you think has more prospect of future appreciation. In that case, consider doing a tax-free Section 1031 exchange. You swap your current property for the replacement property that you think has more upside.
With proper planning and attention to fine 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 minimize your taxes basis in the replacement unit property. And that means you start off with a built-in tax gain on the replacement property.
But if you hold that property until the bitter end, the aforementioned basis step-up rule could work its tax-saving magic for your heirs. 25% Federal government rate on long-term gain attributable to depreciation deductions stated for a rental property. 20% Federal rates on the remainder of long-term local rental property gain or long-term land-sale gain.
3.8% Federal net investment tax rates. State tax rate, if suitable. Doing nothing is not usually a good tax planning strategy, however the greatly-appreciated real property scenario is an exclusion – if you keep hold of the house until death. The other tax-saving strategy is to arrange a tax-free Section 1031 exchange, and then hang onto the substitute property until you depart. If you are interested in the Section 1031 exchange idea, seek advice from a pro who handles these deals frequently. Section 1031 exchanges aren’t good DIY projects but the taxes cost savings can be huge.