By Julie Tumbaga
Old Republic Exchange Company (OREXCO), Vice President and Regional Manager
IRC §1031 provides a way for property owners to build wealth by retaining tax dollars for reinvestment. This point is illustrated by the example below wherein taxpayer Smith – if he sells – is left with $202,520 versus – if he exchanges – he is left with $344,000 to reinvest.
If Smith sells, he must pay federal capital gains tax of 15%, plus Hawaii state income tax of 8.25%. In addition, any portion of his gain arising from depreciation will be taxed at a hefty 25%.
Here is Smith’s situation:
Smith plans on selling his investment real property to Jones for $800,000. With a mortgage of $400,000 and closing costs of $56,000, he will net proceeds of approximately $344,000.
Smith originally purchased his property for $300,000, spent $50,000 on capital improvements and took $150,000 in depreciation. His adjusted basis is $200,000 (i.e. original purchase price, plus capital improvements, less depreciation). His gain on the sale will be $544,000 (i.e. sales price less adjusted basis less closing costs). Compare the result if Smith sells with the result if Smith exchanges:
If Smith Sells:
Sale Price $800,000
Existing Loan: $400,000
Closing Costs: $56,000
Taxes Due: $141,480
Cash Left: $202,520
If Smith Exchanges:
Sale Price: $800,000
Existing Loan: $400,000
Closing Costs: $56,000
Taxes Due: $-0-
Cash Left: $344,000
How does an exchange work?
The Treasury Regulations require Smith to use a third party to act as a qualified intermediary (“QI”), to hold the proceeds from the sale of the property that he disposes of (the “relinquished property”) and invest those proceeds in like kind replacement property. Smith must identify replacement property in writing within 45 days of the closing for the sale of his relinquished property and, within 180 days of that closing, he must acquire one or more of his identified replacement properties. To defer all taxes, Smith must buy only like kind real property, use all cash proceeds and incur an equal or greater amount of new debt.
Taxpayers should plan an exchange only with the help of a qualified tax advisor. For further information or a free brochure about exchanges, please contact Julie Tumbaga of Old Republic Exchange Facilitator Company at 877-591-1031. Old Republic Exchange Facilitator Company (OREXCO) does not give tax or legal advice.
About the Author: Julie Tumbaga is Vice President and Regional Manager for Old Republic Exchange Company (OREXCO) 1031 Exchange for the State of Hawaii. With 15 years of experience in the real estate industry, she brings an extraordinary level of knowledge and experience to OREXCO’s clients.
Old Republic Exchange Company (OREXCO)
Julie Tumbaga
toll free: 877.591.1031
Statements or expressions of opinion appearing herein are those of the authors and not necessarily the views or opinions of MAUI, A Property Portfolio LLC, its publishers or staff. MAUI, A Property Portfolio LLC, its publishers and staff disclaim any liability arising from reliance upon any information or opinions contained herein.
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