Introduction
If you are a real estate investor, then you probably already know about traditional 1031 exchanges. A 1031 exchange allows investors to defer capital gains taxes when they sell an investment or business-use property and reinvest the proceeds into another “like-kind” property. Rather than paying taxes immediately, investors can preserve more of their equity and continue building wealth through real estate.
Qualifying for a 1031 exchange entails extensive following extensive IRS rules and timelines.
But what if you are TIRED of being a landlord? Real estate investing provides a great stream of income and investing in real assets is a great diversifier in a portfolio. However, being a landlord is a lot harder than most people realize. Vacancies, bad tenants, house maintenance, etc. can become headaches and very expensive.
If you are tired of being a landlord and want to get out of the real estate investment property you have, there are still ways to do that AND defer capital gains taxes. This will be a series of blog posts that talk about various ways to quit being a landlord and continue deferring capital gains taxes. There are lots of strategies like converting it to a primary residence, offsetting gains with capital losses, etc. However, this blog series will discuss the various products that you can use for a 1031 exchange and the pros and cons of each:
- Delaware Statutory Trusts
- UPREITs
- Charitable Remainder Trusts
- Intermediary Installment Sale Trusts
For now, let’s discuss some basic glossary terms to bring everyone on to the same level!
Capital Gains Tax
Capital gains tax is a tax you pay on the PROFIT you earn from an investment. These will apply to investments (real estate, stocks, ETFs, mutual funds, etc.) that are NOT in a Qualified Retirement Account (401k, IRA, Roth, etc.). When you sell the investment, you have to pay taxes on the gains. The tax rate you pay depends on how long you have owned the investment.
Short Term Gain
If you own the investment for 1 year or less, the tax rate matches your income tax bracket.
Long Term Gains
If you own the investment more than 1 year, the tax rate is the Capital Gains Rate which is generally a cheaper tax rate.
Cost Basis
This is the cost of the investment. For real estate purposes, this includes the purchase price for the investment PLUS capital improvements.
Example:
Purchase price: $400,000
Capital improvements: $50,000
Adjusted cost basis: $450,000
Sale price: $700,000
Selling expenses (commissions, closing costs, etc.): $40,000
Net sale proceeds: $660,000
Taxable capital gain: $210,000
Step up in Basis – If you hold an investment to death, there will be a “step up in basis.” Using the above example – if the Adjusted Cost Basis is $450,000 and the value of the investment is $700,000 at the time of death, then the new cost basis at death is now $700,000. This is a huge benefit for the heirs of this investment. This also applies to married couples for joint investments. If a spouse passes away, the surviving spouse will also get a step up in basis.
US FEDERAL TAX RATES
| Income Type | Typical Holding Period | Taxed At |
|---|---|---|
| Salary or Wages | N/A | Ordinary income tax rates (10%–37%) |
| Rental Income | N/A | Ordinary income tax rates (10%–37%) |
| Short-Term Capital Gain | 1 year or less | Ordinary income tax rates (10%–37%) |
| Long-Term Capital Gain | More than 1 year | Capital gains tax rates (0%, 15%, or 20%) |
About the Author:
Sara Rodewald
FINANCIAL ADVISOR
208.385.0739
208.781.1932 cell
sara@familytreefinancial.us
Sara is a native Texan and has a BS in Psychology, a Graduate Certificate in Advanced International Affairs, and a Master’s in Public Administration from Texas A&M University. She comes from a career as an intelligence analyst in the federal government and has been fortunate enough to have traveled all over the world. Sara also holds an Idaho Real Estate License and has been a Top Producer. She loves helping people take their first step toward acquiring wealth through real estate. She joined the Family Tree Financial family as the Director of Operations and quickly transitioned into a Financial Advisor role.