May want to sell off a couple of our investments. They have been owned for 10 years. If we did a 1031 exchange and held the property for a minimum of a year, would that benifit us regarding capital gains and depreciation recapture.
In other words, will my capital gains tax and depreciation be at a step up bases on the newer exchanged property (which was held only a year or so) OR will I be taxed based on the original investments from 10 years ago?
Also, anyone have other creative/legal ways to sell off property with minimal gains tax?
Hey,
What happens if if 1031 to a rental house then move in ourselves after a year or so and make it our primary residence? Then say, we sell it after 10 years. Does that change the capital gains from the original investments? In other words, would the tax owed then come from any gains over $500,000 for married couples? And what happens with the depreciation recapture?
Thank you
The idea is to swap till you drop…yes there is a step up in bases on your next property. You however can do a partial exchange and only pay taxes on what you dont want to reinvest. We always recommend getting a great CPA. A few dollars spent on a CPA will save you thousands on Taxes. Timcor has been doing 1031 exchanges for 28 years and we only charge $250 per property in the exchange which also saves you thousands of dollars in Taxes.
The “step up in basis” for inherited property does not apply to exchanged property, and, you don’t avoid depreciation recapture on the relinquished property.
As stepped up basis applies to inherited property, the appraised value of the property on the date of the owner’s death becomes the cost basis in the property for the heir(s). Then if you immediately sell your inherited property for its appraised value, you have no taxable capital gain because the sale price is your cost basis.
Property acquired in a 1031 exchange does not get its value “stepped up” to its purchase price. Instead, when you do a 1031 exchange, the adjusted cost basis in your relinquished property becomes the new basis in your replacement property. If your exchange is a trade for properties of equal value, then there is no change in your adjusted cost basis.
By way of illustration, let’s say your adjusted cost basis in that investment property you held for rental use for 10 years is $30K after all adjustments for capital improvements and allowed depreciation. Now when you sell this property for $200K, you will have a taxable capital gain of $170K. If you later purchase another rental property for $200K, your cost basis in this new property will be your purchase price of $200K.
Instead of selling your rental property, paying capital gains taxes, and then using after tax dollars to purchase another rental property, you elect to use a 1031 delayed exchange to defer capital gains taxes on the sale of your rental property. Under the exchange umbrella, you “sell” your $200K property and “purchase” a qualified replacement property for $200K. Your cost basis in the replacement property is the same as the cost basis you had in your relinquished property – $30K – and you continue depreciating this cost basis on the 17.5 years you have left on the relinquished property’s depreciation schedule.
When you sell your replacement property in a taxable event, all the unrecaptured depreciation taken since May 1997 (including the depreciation carried over from the relinquished property) will be taxed at 25%.
Let’s convert the replacement property in my previous example to your primary residence after one year of rental use. Your adjusted cost basis in this property is $28285 at conversion ($30K minus another $1715 in depreciation). Let’s say you use this property as your primary residence for another 10 years while you enjoy an average 7.2% annual appreciation rate. Your $200K property is now a $400K property. You did not make any capital improvements at all.
Ignoring selling costs and settlement costs, your profit on the sale is $371,715 ($400K sale price minus $28285 adjusted cost basis). Even though this property was occupied as your primary residence for the past 10 years, the depreciation that you were allowed when it was a rental is still recaptured. The portion of your capital gain (profit) due to unrecaptured depreciation is taxed at 25%. The capital gains exclusion on the sale of your principal residence would be applied to the rest of your sale profit
