Pros and Cons of Selling vs Exchanging08.31.2011 Assume a California real estate investor has held an investment property with no debt for many years and will have $500,000 in net proceeds after closing. Invalid table
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Compliments of Dino Champagne
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A §1031 Qualified Intermediary
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Pros and Cons of Selling vs. Exchanging
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Assume a California real estate investor has held an investment property with no debt for many years and will have $500,000 in net proceeds after closing. Also assume this property has $500,000 of capital gain and $200,000 of this gain is due to depreciation recapture. As you can see in the comparison below, the investor who exchanges can obtain considerably higher investment returns from deferring the payment of capital gain taxes. The current low rates for financing provide a unique opportunity for investors to lock-in excellent loan terms. Investors should explore the possibility of exchanging before closing on the sale of investment property.
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SALE (CASH OUT)
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1031 EXCHANGE (REINVEST)
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Capital Gain Taxes Owed
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$141,500 *
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$0(no taxes owed in the current tax year)
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Net Income to Invest
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$358,500 (proceeds less taxes owed)1-5% possible cashflow (assume 3%)
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$500,000 (entire amount of proceeds received). Many real estate investments provide 6-10% cash flow (assume 8%)
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Possible Income
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Bank CD, Bond Fund, Money Market. Assuming a 3% **
return on $358,500
$10,755/annual income
$896/monthly income
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Residential Rental, Commercial, Agricultural Land, etc. Assuming a 8% return on $500,000
$40,000/annual income
$3,333/monthly income
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Preferential Tax Treatment
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Income is not tax-favored if earnings are in a non tax-
qualified account. May be
fully taxable.
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Income generated is tax-favored. Income can be partially sheltered with write-offs. Depreciation tax benefits are also available.
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Liquidity
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Very liquid if 100% cash
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Real Estate is generally not very liquid.
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Diversification
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Yes
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Yes, but must reinvest in real property. May diversify by asset dassand/or geography.
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Time Restrictions
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None
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Yes, 45 days to identify replacement property.Maximum of 180 days to close on replacement property.
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Replacement Asset Basics
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Basis equals purchase price
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Only partial basis for new depreciation. Basis equals purchase price minus deferred gain.
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FOOTNOTES:
* Depreciation Recapture: $200,000 x 25% = $50,000; Remaining Federal Capital Gain: $300,000 x 15% = $45,000; State Taxes: $500,000 x 9.3% = $46,5000 Total Capital Gain Taxes = $141,500; After-Tax Proceeds Available: $500,000 - $141,500 = $358,500
** Today’s inordinately low rates of return for money market accounts, bank CDs and other liquid investments tilt the consideration in favor of exchanging.
This example is for education and illustrative purposes only and is not meant to provide the details for any specific portfolio or rates of return. Accordingly, you should review the details of your specific transaction with your own legal or tax advisor.
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Contact Asset Preservation
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Dino Champagne
(310) 508-7367
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HQ 800.282.1031
NY 866.394.1031
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This information was provided by Asset Preservation and the information contained herein should not be relied upon as a substitute for tax or legal advice obtained from a competent tax and/or legal advisor. As a “Qualified Intermediary” as defined in the Section 1031 regulations, Asset Preservation, Inc. is not able to provide tax or legal advice. Accordingly, you should review the details of your specific transaction with your own legal or tax advisor.
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