1031 EXCHANGE TAX FAQs
Corcapa 1031 Advisors
Paying the taxes versus “swap until you drop”
Some investor choose to pay the taxes on the sale of their property feeling that the tax will eventually be due so why not now. However, many investors take the “Swap Until You Drop” approach which means they will continually 1031 exchange their real estate until they pass away allowing their heirs to receive the “stepped-up” basis in value and significantly reducing or elimination any federal and state tax burden.
Do I still receive a depreciation on the income like traditional property ownership?
Yes, DST ownership is similar to traditional real estate ownership and the year-end tax reporting with your share of the depreciation expenses.
What is my tax bill if I do not 1031 exchange?
Corcapa does not provide individual tax advice but total tax can exceed 40% depending on how long the property has been owned, depreciation claimed and remaining basis. If you are a resident of a tax-free state then your tax bill is often less than 40%.
15 – 20% tax on capital gain. Capital gain tax rate increases from 15 – 20% when Adjusted Gross Income (AGI) exceeds $418,400 per 2017 tax reform.
Depreciation is taxed at 25%. The gain from sale is primarily capital gain as described above but some will be taxed at 25% federal rates.
3.8% Medicare Surcharge, often referred to as Obamacare tax.
The gain and/or depreiation described above is also taxed by the states at the individual state level.
Corcapa strongly recommends that you discuss the actual tax bill with your tax advisor.
Will I receive a K-1 or a 1099? What is the name of the tax document?
Investors will receive either a 1099 or Substitute 1099 or a Profit and Loss statement (PnL) that contains the information for your tax advisor to input on schedule E of the 1040 tax return. You will not receive a K-1 as K-1s report partnership income and partnerships are not eligible for 1031 exchange.
See this Inland video on understanding the tax document: http://go.inland-investments.com/Substitute-1099-1098
How do you compute basis?
Basis from the relinquished (sold) property to the replacement (new) property must be carefully tracked and calculated by your tax professional to ensure a successful 1031 exchange.
In 1031 exchange your gain is deferred until a sale occurs or there is a step up in basis.
A very simple basis can look something like this: the price you paid for the property, less depreciation claimed over the years of ownership, plus any improvements to the property, plus any additional adjustments.
One way to garner additional depreciable basis, and subsequently shelter to cash flow, is to acquire debt with leveraged DSTs. This debt brings risk that would not occur in an all cash property but the benefit is the potential shelter of income.
When the new replacement property is sold in the future (assuming no further 1031 exchange), the original deferred gain, plus any additional gain realized since the purchase of the replacement property, is subject to tax.
One multifamily portfolio DSTs involves four different states – does that require a tax return from all of those states?
Yes, you have to file tax returns in all states where you earn income unless it’s a tax-free state, such as Florida, Tennessee, Nevada, Washington ect. Its possible that one would be under the income threshold for filing in some states too, so verify with your tax advisor.
Does this mean I will be paying double state taxes?
No. If you pay one state taxes due, then typically your home state will give you a credit on what may be owed in that state. For example, California taxes can be 9 – 13.3%. If you pay 4% tax in Colorado, then the difference would be due to the California Franchise Tax Board.
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