How Much Tax Will I Have To Pay?
After you decide if your property will qualify for an exchange, you should decide if you should simply sell the property and pay the tax, or do an exchange and defer all the capital gains tax.
To estimate the federal income tax you will have to pay if you sell the property and do not do an exchange, let's use the following example to determine the tax you will have to pay.
Example:
You sell a property for $180,000 and have $15,000 of selling expenses. Your starting cost basis was $120,000, and you
made improvements worth $10,000. You took depreciation of $60,000.
| Taxable Gain if property is sold | ||
| Selling Price | $180,000 | |
| Selling Expenses | -$15,000 | |
| Equals: Adjusted Selling Price | $165,000 | |
| Starting Cost Basis | $120,000 | |
| Plus: Improvements | +$10,000 | |
| Equals: Adjusted Cost Basis | $130,000 | |
| Less: All Depreciation Taken | -$60,000 | |
| Equals: Adjusted Tax Basis | -$70,000 | |
| Total: Taxable Capital Gain | $95,000 | |
Starting Cost Basis: If you obtain a property in a straight purchase, then the owner's starting Cost Basis is basically the purchase price with some additional acquisition costs. If the property was received in some other way, such as part of an exchange, an inheritance, on death of a spouse, or in a partnership distribution, you need to know what basis was assigned to the property when received. Any improvements to the property are added to the starting cost basis.
Adjusted Tax Basis: After adding any improvements to the starting cost basis all of the depreciation taken or allowed is subtracted to obtain the Adjusted Tax Basis.
Total Taxable Gain: The potential Taxable Gain is the Adjusted Tax Basis subtracted from the Adjusted Selling Price.
| Adjusted Selling Price | $165,000 |
| Adjusted tax Basis | -$70,000 |
| Taxable Capital Gain | $95,000 |
If the property is sold this is the amount that will be added to your Taxable Income. The amount of Capital Gain !!!
Remember: When selling real estate Capital Gain is: PROFIT + Recaptured Section 1250 DEPRECIATION.
NOTE: The debt on the property is not considered when figuring the capital gain.
Federal Tax Due: While the long term capital gains rate is 15% (effective for property transferred on or after May 6th, 2003) on the profit from the sale of real estate, the computation of the total federal tax due is complicated by the separate 25% tax rate for recapture of depreciation.
| Federal Tax Due on Gain of Property Sold | ||
| Recapture of Section 1250 Depreciation | $60,000 x 25% | $15,000 |
| Capital Gain on Profit | $35,000 x 15% | $5,250.00 |
| Total: Federal Tax Owed | $20,250 | |
In the above example, if you were to do a totally tax-deferred exchange, you will defer $95,000 of taxable gain and have $20,250 more to reinvest in real estate.
Reinvestment: See the Reinvestment Rules page for dollar requirements when purchasing the replacement property.
