One of my business associates just sent to me the below scenario for investors to consider on whether to sell their investment property this year and pay the tax or next year. Here is his work up for your review:
Capital Gain Tax
Absent any action from Congress, the Federal Capital Gain Tax Rate increases on January 1, 2013 to 20% from 15% for gain recognized on appreciation in value. The Tax Rate on the Recapture of Depreciation is scheduled to remain unchanged at 25%.
$1.1 Million sale price
$100k closing costs (commissions, title premium, escrow fees…)
$1 Million net sales price
$250k adjusted basis (includes $200k of depreciation allowed)
$450k initial purchase price
|2012 Closing||2013 Closing|
|$1.1MM – $100K – $250K =||$1.1MM – $100K – $250K =|
|$750K realized gain||$750K realized gain|
|$200K * 25% = $50K||$200K * 25% – $50K|
|$550K * 15% = $82.5K||$550K * 20% = $110K|
|$132,500 of tax||$160,000 of tax|
3.8% Health Care Tax
Additionally, beginning January 1, 2013 Taxpayers could be subject to a 3.8% tax on investment income as provided in the 2010 health care bill. The tax will be imposed on investment income including but not limited to capital gains, rental income, interest and dividend income. The impact of the tax on sales of property, in addition to the capital gain tax on the sale (25%/20%), is the burden of an additional 3.8% tax. The new tax on investment income results if the taxpayer is a passive investor in relation to the investment creating the income. There are many nuances to this tax, so it may not be as bad as it initially appears, but it must be contemplated in your decision to sell.
A single person with a $1 million Adjusted Gross Income with $750k of recognized gain (per the example above) from a sale of a passive real estate investment would pay 3.8% on the lesser of AGI above $200k or the recognized gain. In this example: ($1million-$200k)>$750k. 750,000*3.8% = $28,500 of additional tax
A 1031 Tax-Deferred exchange allows you to defer all gain recognition and therefore not have any tax liability on your sale. The gain will also be excluded from the calculation of the 3.8% tax.
So, there is a $56,000 incentive to close in 2012 rather than in 2013 ($132,500 v. $188,500) or an even greater incentive to defer the gain entirely by acquiring another property through a 1031 exchange.
We urge you to consider and discuss the information contained herein with your professional tax advisor. We look forward to working with you in the future. Our 1031 consultations are FREE, so if you have a question please feel free to contact Dave at 602-793-1558.