THE WASHINGTON POST.
SATURDAy, MARCH 14, 2020EZ
6A 1031 exchange requires you
to identify y our replacement
property w ithin 45 days and t o
close on your replacement
property w ithin 180 days of
settling your D.C. property. A 1031
exchange a llows you to defer
liability for all federal capital
gains and depreciation recapture
taxes.
You can sell your D.C. property
and pay no federal income taxes
on that gain s o long as you use a
qualified exchange intermediary
to hold your funds and you
reinvest your entire sales
proceeds in a new investment
property h aving a value equal to
or greater t han your D.C.
property.Harvey S. Jacobs is a real estate lawyer
with Jacobs & Associates Attorneys At
Law in Washington and Rockville, Md.
He is an active real estate investor,
landlord, settlement attorney, lender
and associate real estate broker. This
column is not legal advice and should
not be acted upon without obtaining
your own legal counsel. Contact Jacobs
at 301-417-4144, Jacobs@Jacobs-
Associates.com or
[email protected].$61,770 in total f ederal tax
liability,” Wexler said. Your pretax
cash profit minus y our federal tax
liability results in $268,230 in
after-tax profits, which will be
further reduced by state capital
gains and depreciation recapture
taxes.
Because this is investment-
only property, you are not eligible
to use the $ 250,000 ($500,000 f or
a married c ouple) capital gains
exclusion available when you sell
your primary residence. IRS Pub.
544, available online at i rs.gov,
contains detailed instructions f or
calculating c apital gains a nd
depreciation recapture f or
residential rental p roperty.
Because your current plan to
sell investment property r esults
in significant tax liabilities with
no real tax a dvantages, one way
to dramatically i ncrease your
after-tax profit is to consider
using a 1031 exchange. This IRS
code section allows you to
exchange y our D.C. property a nd
reinvest your cash in another
like-kind replacement
investment, such as other rental
real estate or a Delaware
Statutory Trust.liability would be $34,500,” s aid
Eric J. Wexler, a Rockville, Md.,
tax attorney and CPA.
IRS regulations generally
require that you depreciate
residential rental p roperty o ver
27.5 years (3.636 percent per
year). B ecause land d oes n ot wear
out, the IRS does not permit you
to depreciate the purchase price
attributable to the land. To
calculate your depreciation
deductions, we assume: your
$400,000 purchase price w as
allocated equally between the
land and the original
improvements; and that the
additional capital improvements
were made b efore the home was
placed into service as a rental
property. As s uch, your property’s
“depreciable base” i s $300,000.
Accordingly, you were able to
take $10,908 a nnually for t he 10
years it was r ented, for $ 109,080
in t otal cumulative d epreciation.
“Now that you are selling, t his
noncash tax deduction must be
paid back, in part, as depreciation
recapture tax. So, in addition to
your $34,500 in capital gains tax,
you will i ncur $27,270 in federal
depreciation recapture t ax, f orinvestment income above c ertain
thresholds.
Capital g ain is the d ifference
between your selling price and
your adjusted tax basis. The
Internal Revenue S ervice c lassifies
capital gains a s either s hort or long
term. Gain o n the property s ales
held for one year or less is
considered short term a nd is taxed
at y our ordinary income tax rate.
Gain on property s ales held for
more t han one year i s classified as
a long-term capital gain and is
taxed at rates ranging from 0
percent to 20 percent. Most
homeowners will p ay a t the 1 5
percent rate.
Although you state that your
pretax cash profit is $ 330,000,
your taxable l ong-term capital
gain is only $230,000. Ta xable
capital gain is calculated by
taking y our s ales price
($800,000), minus c ommissions
and closing costs ($70,000),
minus y our adjusted tax b asis
($500,000). Your adjusted tax
basis is your original c ost plus
your capital i mprovements.
“A ssuming you are in the 15
percent capital g ains tax bracket,
your federal capital g ains taxQ: I am selling a
house in the
District t hat I
bought 1 0 years
ago, renovated
and have rented
out as an investment ever since. I
paid $400,000 a nd c an now s ell
for $800,000. I immediately
renovated the kitchen a nd baths,
which cost $100,000. At
settlement, I plan on paying
$48,000 in real estate
commissions, $ 11,600 in D.C.
transfer tax and an additional
$10,400 in closing costs and seller
credits to buyer. My p retax cash
profit should be a bout $330,000.
What are the tax implications,
and what can I do to m aximize
my a fter-tax profits?
— Savvy SellerA: Congratulations on
successfully investing in a rental
property. When y ou sell your
rental property, y ou w ill i ncur
federal and s tate long-term
capital gains a nd d epreciation
recapture taxes. You may also
incur the Net Investment Income
Ta x, which imposes an additional
3.8 percent tax on your netInvestment Property
1031 exchange can help maximize your after-tax profit from sale
House
Lawyer
HARVEY S.
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