Pat Hune, Broker, 1st Southwest Realty, January 2019
Recently one of my clients sold a property she had owned as a rental for several years. She decided to sell the property and do a 1031 exchange. If you are not familiar with 1031 exchanges you can find all the details in my article titled 1031 Exchange Alternatives.
The short description is the ability to exchange one investment property for another and postpone the taxes on the capital gains and depreciation recapture. The taxes are not paid until you decide to sell the property without doing another exchange. Unfortunately for my client she did not have a tax advisor who was experienced with 1031 exchanges that could help explain the pros and cons. I advised her to speak to my accountant, Jeffrey Quatrone. Jeffrey gave the following advice: “It is my opinion that postponing the gain on a sale may not always be best, unless you expect to eventually pass the assets to an heir. My reasoning is that currently tax rates are at historical low. In the future, I feel tax rates will have to rise to tackle the surmounting debt the U.S. government is adding to its balance sheet resulting in a higher tax in the future.
As to your question of what taxes will I owe if I decide not to use the 1031 exchange, you will need to calculate the gain and the depreciation the IRS requires you to recoup. You must recoup depreciation taken even if you did not write it off. This is taxed based on your regular income tax bracket (up to 25%). The remaining will be taxed at your capital gain rate applicable to your income (0% and up to 20%).
If you do not want to participate in the 1031 exchange and still defer the gains tax, you can consider either selling your property on the installment sale (hold the note yourself) or consider investing in a Qualified Opportunity Fund. You would only have to invest the actual gain from your rental property sale. There are several funds in Arizona, and most any state, where you can invest the proceeds using a 1031 exchange.” Deferring Tax on Gains-Tax Reform on Gains
The bottom line is if you decide to sell an investment property be sure to talk with an accountant who is familiar with the pros and cons of a 1031 exchange.