It’s that time of the year when almost everyone has taxes on their minds. For many individuals they are eager to see how much their refund will be, but for many real estate investors it is a time we cringe thinking about how much we may owe. I recommend a tax plan throughout the year that allows you to keep track of how much you will owe at the end of the year, and to learn some tax reducing strategies to implement throughout the year. I was asked a question recently by another Alabama real estate investor about short term versus long term capital gains and how they are taxed, and how 1031 exchanges can help. See my thoughts below:
Short term capital gains are profits that been realized on properties that have been held for less than one year. Short term capital gains are taxed the same as ordinary income. This is based on one’s personal income tax rate, which is determined by income. An individual’s tax rate can be anywhere between 0% and 37% of income, depending on income amount and filing status. The IRS and many other websites have charts to help the taxpayer determine his tax rate.
Long term capital gains are profits realized on properties held for more than one year, and these gains are taxed differently than short term capital gains. Long term capital gains are taxed at 0%, 15% or 20%. Again, filing status and income determine which the taxpayer’s tax bracket.
A 1031 exchange allows a taxpayer to defer taxes on profits when doing a “like-kind” exchange. A “like-kind” exchange is what it sounds like- exchanging one property for another of it’s kind. This means that one cannot do a 1031 exchange when he sells a piece of real estate and uses the profits to invest in precious metals. Real estate is “like-kind” with other real estate. So the taxpayer could do a 1031 exchange if he sells a single family home and buys a duplex, apartment building, or commercial property with the profits. There are timelines for how long the properties must be held and how quickly the taxpayer has to identify and close on the second property, along with other guidelines for making sure that the 1031 exchange is legitimate, so the savvy real estate investor should consult with competent tax attorneys and accountants to discuss the specific situation. It is recommended that the real estate investor has a comprehensive tax plan as it relates to real estate and it’s effects on one’s whole financial picture- both now and into the future.
TJ Sayers