How to Defer Capital Gains Tax

If you own investment real estate, when the time comes to cash in on your hard earned equity, you may be surprised to find that the capital gains tax may dramatically cut into your net profit.  Currently the Federal Capital Gains tax rate sits at 15%.  If you live in the great state of California, go ahead and tack on another 9.3% for a combined rate of approximately 25%.  And don’t forget about the depreciation recapture tax on top of your capital gains tax.  This one’s a real sleeper.  Federal Depreciation Recapture Tax is at 25% and in the state of California, you can go ahead and tack on another 10%; combined Depreciation Recapture Tax of 35%.  So what exactly does all this mean?  Let’s look at an example:

Let’s say you bought your California Condo in 1987 for $150,000.  In 2007, your property is now worth $650,000.  You now have accumulated about $500,000 in equity.  Awesome! The time has come to sell the property and cash in and the golden egg.  The tax consequences might look something like this:

• Gross Equity Gain                            $500,000
• Less Cap. Gain Tax of 25%              (125,000)
• Less Dep. Recap. Tax of 35%            (38,182)
• Net Gain After Taxes                      $336,872

Now don’t get me wrong, $336k is a nice chunk of change to add to the savings account, but I’m sure we would all agree that the full $500k would be better.  So is there anything out there to help us solve this issue of capital gain and depreciation recapture tax?  Of course there is!  If you decide to sell your highly appreciated asset and cooperate in a 1031 Tax Deferred Exchange, you can roll the entire gain into another investment that may better position your overall portfolio to increase cash flows and net worth.  Let’s look at the basics of an exchange:

1.       Sell Relinquished property

2.       Assign a Qualified Intermediary to facilitate transaction

3.       ID replacement property within 45 days of COE of relinquished property.

4.       Replace all equity in the replacement property

5.       Replace all debt in the replacement property.

6.       Close escrow on replacement within 180 calendar days of COE of relinquished property.

7.       Enjoy the benefits of keeping all your equity!

So next time you look to sell that piece of property and cash in or move your equity around, be sure to look into the tax consequences by contacting your CPA to help you netter understand what your liability is.  Once you know where you’re at, you can then better figure where you want to go and how you’re going to get there!  Happy investing…