A 92 Year-Old Solution for Real Estate Investors Facing Higher Taxes in 2013:
1031 Exchanges Offer Full Deferral of the New 3.8% Medicare Surtax Tax and 20% Capital Gain Tax
The familiar adage,
“It’s not how much you make, but how much you keep”
rings truer than ever for real estate investors in 2013. Not
only have capital gain taxes increased significantly for high earners,
but many investors below the top tax bracket face an additional 3.8%
surtax on passive investment income like capital
gains. Fortunately, IRC Section 1031, a provision which has been in the
tax code since 1921, provides critically needed tax relief.
Under the American Taxpayer Relief Act of 2012, the top capital gain tax rate has been permanently increased to 20% (up from 15%) for single filers with incomes above $400,000 and married couples filing jointly with incomes exceeding $450,000. In addition, the new IRC Section 1411 3.8% Medicare surtax on net investment income, which includes capital gains, results in an overall rate for higher-income taxpayers of 23.8% -- a staggering 58% increase from 2012 tax rates!
Four Steps Involved in Determining Capital Gain Taxation
Absent
the tax deferral benefits of a 1031 exchange, below is a summary of the
four ways investors will be taxed on the sale of an investment
property:
1)
Depreciation Recapture: Taxpayers will be taxed
at a rate of 25% on all depreciation recapture.
2)
Federal Capital Gain Taxes:
Investors owe Federal capital gain taxes on the remaining economic gain
depending upon their taxable income. Since a new higher capital gain
tax rate of 20% has been added to the tax code, investors exceeding the
$400,000 taxable income threshold for single
filers and married couples filing jointly with over $450,000 in taxable
income will be subject to the new higher tax rate. The previous Federal
capital gain tax rate of 15% remains for investors below these
threshold income amounts.
3)
New Medicare Surtax Pursuant to IRC Section 1411:
The Health Care and Education Reconciliation Act of 2010 added a new
3.8% Medicare Surtax on “net investment income.” This 3.8% Medicare
surtax applies to taxpayers with “net investment income” who exceed
threshold income amounts of $200,000 for single filers
and $250,000 for married couples filing jointly. Pursuant to IRC
Section 1411, “net investment income” includes interest, dividends,
capital gains, retirement income and income from partnerships (as well
as other forms of “unearned income”).
4)
State Taxes:
Taxpayers must also take into account the applicable state tax, if any,
to determine their total tax owed. Some states have no state taxes at
all, while other states, like California, have a 13.3% top tax rate.
