1031 Exchange Example
The following is a 1031 Exchange example:
Relinquished Property:
An investor purchases two rental homes, some storage units and a small office building for a combined total of $750,000. Over the course of ownership the investor spends $50,000 in improvements to the properties and depreciates the assets by $100,000.
Basis Calculation:
The investors BASIS is therefore $700,000 ($750,000 purchase price + $50,000 in improvements – $100,000
in depreciation).
Capital Gains Calculation:
The properties are sold for a combined total of $1,200,000 leaving the investor a CAPITAL GAIN of $500,000 ($1,200,000 selling price – $700,000 basis).
Potential Tax Liability:
Between the federal capital gains tax, state capital gains tax, depreciation recapture tax and Medicare tax this investor is subject to a total tax liability of $150,000 when the sale is completed (this example uses a combined tax liability of 30% but it could be more – actual liability is dependent upon many factors including investor income and the state where the property resides).
Replacement Property Investment Assumptions:
- Proceeds from the sale will be used towards the 25% down payment of a replacement property.
- The replacement property is a Single Tenant NNN property selling for a 6% cap rate.
The investor has the following options:
Option A: pay the taxes and use the remaining $350,000 ($500,000 capital gain – $150,000 in taxes) to serve as the 25% down payment in purchasing a new property worth $1,400,000 ($350,000 / 25%).
Option B: utilize a 1031 Exchange and use all $500,000 towards the 25% down payment in purchasing a new property worth $2,000,000.
Results:
Option A: at a 6% cap rate, this property will provide an annual income of $84,000 ($1,400,000 x 6%)
Option B: at a 6% cap rate, this property will provide an annual income of $120,000 which is 43% more income per year than the Non 1031 Exchange Investment Property
For more detail about 1031 Exchanges, visit the 1031 Exchange Information page.
