1031 Exchange 101: The Basics of Calculating Capital Gains Taxes

In any typical real estate transaction, if you’re selling a piece of property you are going to have to pay capital gains taxes on the net proceeds from the sale. But many taxpayers aren’t sure how to calculate these potential capital gains taxes. In this article, we are going to explain how to calculate your capital gains taxes in a like-kind exchange of real estate.

1031 Exchange Capital Gains Taxes

Putting the numbers together and calculating your capital gains tax burden on the sale of real estate can really show you how much you stand to save by doing a 1031 exchange.

The following is a basic breakdown of how to determine your capital gains tax burden during a real estate transaction:

1. Step 1 – Calculate your net adjusted basis. This is achieved by taking the original purchase price, subtracting depreciation, and adding any capital improvements.

2. Step 2 – Calculate your capital gain. This is achieved by subtracting the net adjusted basis from the sales price, and then subtracting the cost of the sale.

3. Step 3 – Calculate your capital gains tax burden. This is achieved by adding up your federal and state taxes, as well as your depreciation recapture.

Use Our Capital Gains Calculator

For your convenience, we have also put together a free calculator that you can use to calculate the capital gains taxes on your real property.

Click here to use our capital gains calculator.

Contact a Like-Kind Exchange Professional

CPEC1031, LLC has decades of experience in the like-kind exchange industry. Our qualified intermediaries are well respected in Minnesota and across the country. We partner with each of our clients to provide top-notch professional services. Contact us today at our downtown Minneapolis office to speak with one of our 1031 qualified intermediaries about how to defer your capital gains taxes on the sale of real estate with a 1031 exchange.

• Start Your 1031 Exchange: If you have questions about 1031 exchanges, feel free to call me at 612-643-1031.

Defer the tax. Maximize your gain.

© 2021 Copyright Jeffrey R. Peterson All Rights Reserved

The Negative Implications of a Failed 1031 Exchange

In a 1031 exchange there are some pretty brutal and harsh deadlines that you have to meet in order to have a successful exchange. Here are some tips for meeting those deadlines.

Identify by Day 45

You have to identify your replacement property by midnight of the 45th day. If you miss that deadline you are SOL (Statutorily Out of Luck) because the statute says you have to have sent your identification in before midnight of the 45th day.

Fax, Email, Snail Mail

Sometimes taxpayers doing exchanges will fax, e-mail, or FedEx identification to their intermediary so that they have some recorded documentation that it was sent within the proper time frame. If you go to the mailbox and drop your identification in a stamped addressed envelope to the intermediary on the last day of the exchange you may have sent it but you may not have any proof that it was sent, especially if the postal employee doesn't pick up the mail from the mailbox and the letter isn't actually postmarked until a day or two later when it is processed at the mail-sorting service.

To be on the safe side, send the identification by fax and email, and if you want to you can also mail it and try to get the letter postmarked by going directly into a postal office and handing the letter to the postal employee before midnight of the 45th day.

CPEC1031

At CPEC1031, LLC, we work with people in Minnesota and across the country on their 1031 exchanges of real estate. Our qualified intermediaries have over two decades of experience in the 1031 exchange industry. We can help you defer your capital gains taxes on the sale of real estate. Contact us today at our Minneapolis office to learn more!

• Start Your 1031 Exchange: If you have questions about 1031 exchanges, feel free to call me at 612-643-1031.

Defer the tax. Maximize your gain.

© 2021 Copyright Jeffrey R. Peterson All Rights Reserved

2 Tax-Efficient Real Estate Strategies

How would you like a double whammy on your tax return with two awesome tax strategies? In today’s article, we explore two efficient tax strategies that can help you when selling real estate.

Principal Residence Tax Exclusion

The first is the principal residence exclusion. When you sell your principal residence you can exclude up to $250,000 if you’re single or $500,000 married filing jointly on the sale of your principal residence. Many taxpayers are aware of this exclusion and utilize it each year.

1031 Exchange

The other super-powerful tax strategy for real estate is the 1031 exchange that allows you to defer the gain on your investment or business property.

People that own apartment buildings or small residential rental properties that they also occupy a portion of as their principal residence get to use both of these powerful attack strategies on the same closing statement.

A 1031 Principal Residence Example

For example let's say that you own a fourplex that's a small building with four units and you occupy one of those units as your principal residence. Let’s say that you’ve owned the property for 10 years and you've occupied that one unit which comprises one-fourth of the property for at least two of the preceding five years. So you’ve owned it for more than two years, you've occupied it for more than two years, you get to take the portion of the sales proceeds that relate to that one fourth unit as your principal residence proceeds and exclude $250,000 if you're single or $500,000 if you’re married of your gain on the sale of that unit.

The other three units that are used for rent you don't get an exclusion on, you merely get a tax deferral - meaning that you may have to pay the piper in the future if you ever recognize the gains on a subsequent sale of your replacement property. So by using these two powerful tax strategies in the same transaction you can really maximize the benefits to you and keep your hard-earned equity working for you rather than unnecessarily recognizing gains and paying taxes.

• Start Your 1031 Exchange: If you have questions about 1031 exchanges, feel free to call me at 612-643-1031.

Defer the tax. Maximize your gain.

© 2021 Copyright Jeffrey R. Peterson All Rights Reserved

An Explanation of the 1031 Exchange Same Taxpayer Requirement

Let's say that you have a husband and wife (Mark and Sandra) doing a 1031 exchange.

Mark and Sandra own the old relinquished property. When they go to acquire the replacement property the same taxpayers that owned the old property should acquire the new replacement property. So in our example Mark and Sandra should purchase the replacement property so that when they report their taxes on IRS form 8824 they can show that they disposed of a relinquished property and acquired a new replacement property.

But what if Mark wants to set up an LLC to buy the replacement property? Will that LLC be deemed to be the same taxpayer as Mark and Sandra individually?

The answer to that question can depend on what state Mark and Sandra live in. If Mark and Sandra are in a community property state such as Wisconsin or California the common ownership of that LLC by Mark and Sandra will still be viewed as a disregarded entity - a pass-through – where the IRS sees Mark and Sandra as the taxpayers behind the LLC according to Rev. Proc. 2002-69. In this situation, both spouses also have to file a joint tax return.

Community Property States Include:

• Arizona

• California

• Idaho

• Louisiana

• Nevada

• New Mexico

• Texas

• Washington

• Wisconsin

In that case Mark and Sandra could buy the replacement property by and through that disregarded LLC. The problem is that most states are not community property states – they’re common law states. In those states a husband and wife are not considered to be a single member or owners of a disregarded entity. A husband and wife in an LLC could create and would create a separate and distinct taxpayer.

So in non-community property States the options for the taxpayers are either to:

• Acquire the replacement property in their own individual names - Mark and Sandra

• Create two new single member LLCs - one owned by Mark, one owned by Sandra - and have those two LLCs acquire the replacement property as tenants-in-common.

There’s still a continuation of investment by the same taxpayers, they’re simply bifurcating their ownership into two separate and distinct single member disregarded LLCs.

• Start Your 1031 Exchange: If you have questions about 1031 exchanges, feel free to call me at 612-643-1031.

Defer the tax. Maximize your gain.

© 2021 Copyright Jeffrey R. Peterson All Rights Reserved

The Best Way to Handle Earnest Money Deposits when Conducting a 1031 Exchange

So you're doing a 1031 exchange, you’ve sold your relinquished property, and parked your proceeds with the intermediary. If you're like a lot of real estate investors you are real estate rich and cash poor. You don't have a lot of extra cash laying around to advance for an earnest money deposit.

Making an Earnest Money Deposit

How can we make an earnest money deposit on the replacement property if all of your cash is tied up in the 1031 intermediary’s account?

Very easy. Enter into a purchase agreement for the replacement property, give it to the intermediary and say: “Hey intermediary, please assign yourself into this contract so that you can advance a portion of the exchange funds to the seller or the seller's title company as the earnest money deposit.”

Once you have a contract for the replacement property it's very easy to assign that contract to the intermediary so that they step into the shoes as the buyer of that property and can advance the exchange funds.

Be Careful with Loan Related Expenses

What you can't advance money for are loan related expenses, so if you have a loan origination expense don't plan on funding that out of the exchange account.

Sometimes taxpayers don’t want to wait for the slow intermediary to wire transfer the earnest money deposit. Instead they want to write a check and attach it to their offer so it looks more appealing to the seller. Then they say “when can I get my earnest money cash back?”

At the closing of the replacement property you can instruct the settlement agent to not apply the earnest money deposit towards the purchase price, but instead to refund your money at the time of closing. Then your intermediary can come in with all the 1031 funds to fund the acquisition and you’ll get that earnest money back at closing.

• Start Your 1031 Exchange: If you have questions about 1031 exchanges, feel free to call me at 612-643-1031.

Defer the tax. Maximize your gain.

© 2021 Copyright Jeffrey R. Peterson All Rights Reserved