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A Real Estate Sale vs an Exchange

Analyze the Benefits Before Selling

The benefits of 1031 exchanges can be significant for taxpayers who own investment property. Taxpayers have the potential to defer all capital gain taxes, depreciation recapture, the net investment income tax( NIIT), and state taxes. If the requirements of a valid 1031 exchange are met, capital gain recognition will be deferred until the taxpayer chooses to recognize it.

Example:

A married couple filing jointly sells an investment property in North Carolina for $1,000,000 (net of closing costs) with no debt. The couple originally purchased the property for $400,000. Seventy-five percent, or $300,000 of the initial purchase price, was allocated to the building and has been fully depreciated. The capital gain is approximately $900,000 (today’s sales price of $1,000,000 minus the net adjusted basis of $100,000). This is the only source of the couple’s investment income. The couple’s modified adjusted gross income is $1,400,000 (which includes income from other sources and capital gain from this sale) for purposes of calculating the net investment income tax. The couple will be taxed at 25% for their prior depreciation deductions taken, 20% federal capital gains tax rate, the 3.8% net investment income tax and they will be in the 5.25% North Carolina state tax bracket.

Today's Net Sales Price (after closing costs) Less taxes owed$1,000,000
$300,000 depreciation recapture @ 25%= $75,000
$600,000 federal capital gain @ 20%= $120,000
$900,000 net investment income tax @ 3.8%= $34,200
$900,000 state tax @ 5.25%= $47,250
Total taxes owed= $276,450
After-Tax Net Equity
$1,000,000 - $276,450
= $723,550
1031 Exchange Gross Equity= $1,000,000
Reinvestment of Equity with 50% Leverage
*not all exchanges will carry leverage

Taxable Sale: Net Equity x 21= $1,447,100
1031 Exchange: Gross Equity x 21= $2,000,000


The North Carolina taxpayers in this example could potentially purchase a replacement property that is worth approximately $1.4 million more by performing a 1031 exchange instead of a taxable sale. Exchanges provide the opportunity to preserve equity, increase cash flow from larger replacement properties, and enable taxpayers to maximize return on investment.

1 If the investor takes the equity from the sale or 1031 Exchange and levers it up, they could take the $1M and put it into one DST that has 50% leverage you will get a $2M property, or the investor could take the Net Equity of $723,550 and get a bank loan of $723,550 to get a property value of $1,447,100.

This material does not constitute an offer to sell, solicitation of an offer to buy, recommendation to buy, or representation as the suitability or appropriateness of any security, financial product or instrument, unless explicitly stated as such. This information should not be construed as legal, regulatory, tax, personalized investment, or accounting advice. This message (and any attached materials) is for the sole use of the intended recipient(s) and may contain information that is privileged, confidential and exempt from disclosure under applicable law. Any review, dissemination, distribution or duplication of this communication is strictly prohibited

This data is not meant to replace Adviser’s portfolio management/performance reporting systems or brokerage statements. Please consult your reports for actual performance data before making any decisions based on this information. Accordingly, reliance upon information in this data is at the sole discretion of the reader. Assumptions on returns are just that and may or may not come to fruition. Actual returns may not be as projected and are for illustrative purposes only.

Neither EFR (Exclusive Financial Resources, LLC), it’s officers or employees are authorized or permitted under applicable laws to provide tax or legal advice to any client or prospective client of EFR. The tax related information contained herein or in any other communication that you may have with a representative of EFR should not be construed as tax or legal advice specific to your situation and should not be relied upon in making any business, legal or tax related decision. A proper evaluation of the benefits and risks associated with a particular transaction or tax return position often requires advice from a competent tax and/or legal advisor familiar with your specific transaction, objectives and the relevant facts. We strongly urge you to involve your tax and/or legal advisor (or to seek such advice) in any significant real estate or business related transaction.

If you would like to find out more about Sales vs Exchanges please give Exclusive Financial Resources a call at (980) 242-2533, email Louis Herford at Louis.Herford@ExclusiveFinancialResources.com or schedule a 15-minute discussion here.