Tax Guru – Ker$tetter Letter

Q:

Subject: Exchange Question

Yes, an exchange question…

I am debating 1031 vs cap gains, and wondering about the middle ground, a partial exchange.

I bought the property for 180 +20k improvements – 8300 in depreciation.

The selling price is 475k. Fees are 25k approx.

The state tax rate I believe is 9.3 in California as it is taxed at ordinary income.

The fed rate is 15% I think. At any rate I come up with a cap gains tax of 63k, ouch.

What if I purchased a 250k home with a 70k loan? What would my cap gains be reduced to?

Is that a good question?

A:

It’s impossible for anyone but your personal tax advisor to give you a precise figure on your possible taxes from the proposed partial exchange because it is not a simple calculation.  There are other factors that could affect your tax, such as capital losses, suspended passive losses, and carry forward investment interest.

From your figures, you are looking at a possible taxable gain of $200,000, representing the amount you are missing the target replacement price by (450-250).  The tax on that will include a 25% Federal tax on the depreciation recapture, in addition to the 15% rate on the additional gain.

To see whether a 1031 exchange with such a huge trade-down in value makes sense, have your tax person plug your numbers into his/her tax program to run the figures for you.

Good luck.

Kerry Kerstetter