Calculating Capital Gains Tax for 1031 Exchanges
If you are selling property and involved in a 1031 exchange, you certainly want to know what your deferred tax liability is. The important thing to remember is that you are taxed on your gain, NOT on your profit and NOT on your equity. In other words, you can sell your property, have no profit and no equity, and still be subject to tax liability under the 1031 rules because there is a gain. How can you calculate what you might owe? Well, see an accountant. But if you’re stubborn and you refuse to go to your accountant, here’s a little formula that will point you in the right direction:
First of all, you need to calculate your Adjusted Basis. To do this, take your original purchase price, and then add the cost of your improvements (assuming you have not already claimed them as expenses). Then subtract any depreciation you have already taken, and you have arrived at your Adjusted Basis.
Next, subtract your Adjusted Basis from your current sales price. Then subtract your closing costs (i.e. title fees, real estate commissions, etc.). The number you end up with is your Total Gain on Sale.
Finally, take your Total Gain on Sale and make the following three calculations: 1) Multiply your Total Gain by the state capital gain tax rate; 2) Multiply your Total Gain by the federal capital gain tax rate; and 3) Multiply your Total Gain by the federal 25% tax rate. The sum of these three numbers is the approximate amount of taxes that you can defer through a 1031 exchange. There may be some additional deduction for state taxes.
I strongly recommend that before entering into a 1031 transaction, you speak to your accountant and make sure you understand the pros and cons of the 1031 exchange, and that you are clear about how much tax you are deferring! For more information on 1031 exchanges in general, please see here.