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Robin D.
Robin D., Senior Tax Advisor 4
Category: Tax
Satisfied Customers: 7434
Experience:  15years with H & R Block. Divisional leader, Instructor
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I want to do a 1031 exchange. The house I would be selling

Customer Question

I want to do a 1031 exchange. The house I would be selling is worth $115,000 and the investment land I want to exchange it for is $50,000. How would this work as far as capital gains? What would be the capital gains on this. Do you take out real estate commissions and repairs from the house value?
Submitted: 3 years ago.
Category: Tax
Expert:  Robin D. replied 3 years ago.

Robin D :

Hello and thank you for using Just Answer

Robin D :

There are 2 rules in a 1031 exchange that must be followed:

  1. The total purchase price of the replacement "like kind" property must be equal to, or greater than the total net sales price of the relinquished, real estate, property.

  2. All the equity received from the sale, of the relinquished real estate property, must be used to acquire the replacement, "like kind" property.

Robin D :

There can still be a 1031 exchange but when the replacement property purchase price is less, there will be a tax responsibility incurred and if not all equity is moved from the relinquished to the replacement property, there will be tax.

Robin D :

If the value of the replacement property is less you would be taxed on the greater of the trade down in value or equity, limited to the gain you would have recognized if the property simply had been sold for its fair market value. For real property assets, basis is the term given to the price that was originally paid for the property, plus any capital improvements, less depreciation.

Customer :

How much will I pay in taxes on this if at 25% income tax bracket -- no depreciation just 5% realeste commision on the house and 10,000 in repairs.

Customer :

taxed on the greater of the trade down in value or equity, not sure what that means. It house selling is 100,000 in value and land is 50,000 in value am I taxed on the difference, 50,000? Less real estate commision and repairs to the house?

Customer :

Since the land is less than the relinquished real estate property does that mean I cannot use and exchange as stated in rule 1.

Robin D :

If no depreciation then you will be taxed at the 15% for CG rate. If you gain on the property was $75000 if you just simply sold it but the replacement property for the 1031 is only $50000, then your taxable portion would be $25000. This is how the 1031 works when you exchange for lesser valued property.

Customer :

Where do you get the percentatge, 15% we saw on the internet it depended on your income tax bracket, is that not correct? Is capital gains tax always 15 %?

Robin D :

You said the 25% tax bracket so when you are in that tax bracket you pay 15% for Capital Gains.

Tax Bracket Capital Gain Tax Rate
Short Term Long Term
10% 10% 0%
15% 15%
25% 25% 15%
28% 28%
33% 33%
35% 35%
Customer :

Also not sure if you answered: Do realeaste commissions and repairs come out of the sale of the house as lowering the "gain." 100,000 house -5000 commission - 10,000 repairs. 100,000- 15,000 (repairs and realeste commision = 85,000 - 50,000 land means tax on difference of 35,000 at 15% is this correct? Capital gain tax is $5250.00?

Robin D :

To get your adgusted basis in the property you are allowed to use commissions and other items. Start with the price you paid for your property, add any capital improvements (not repairs and maintenance), and subtract any depreciation (you said there had been none but if this was rental then the depreciation that could have been used is calculated). This figure is your adjusted basis. Subtract the adjusted basis and the new costs of sale (here is where your commissions come in) from the new sales price and the remaining figure is your gain.

Customer :

We would be holding house for over a year too. That means long term I guess. If we lived in the house for 2 years no capital gains.

Robin D :

Is this your personal home that you are looking to exchange?

Customer :

Oh I thought repairs counted and not improvements . This is a house we inherited and are not living in or at this point renting either. We live in another home.

Robin D :

Well then that is fine. A personal residence is not allowed for 1031 exchange. If you lived in your main home for 2 out of the last 5 before a sale you are allowed upto $250,000 exclusion of gain ($500,000 if married filing joint).

Robin D :

Just make sure that you follow all the rules for th eexchange and the time requirements as to completion.

Customer :

Do repairs come out of the first house, lowering the gain or not. You said you add improvements.

Customer :

capital improvements

Robin D :

Not repairs, you can use the cost of capital improvements (those items that extend the life or add value) things like painting no but if you added a room then yes, repaired the kitchen sink no but replaced the sink yes.

Customer :

Did my figures make sense $5250.00 tax

Customer :

so capital improvement come out of the value of the house or not if you improve it by 15,000 and the house was 100,000 does the house now show as valued at 115,000

Robin D :

Yes , the capital gains rate is based on the total income from all your income. This would include the sale gain added to other income. The capital gain rate is only on the sale of the property that could not be deferred due to 1031 exchange but the gain on the sale is added to all income to see what you marginal tax rate is which will then decide your capital gain rate.

Robin D :

If you inherited the house and it was valued at $100000 when you inherited it then if you put $15000 into the house as capital improvements the house then has an adjusted basis of $115000

Customer :

Do I get to subtract repairs that I paid for on the house along with the real estate commisions and was my $5250.00 figure correct or not. I need to know how repairs and improvements impact the value. It sounds like improvements work in my disfavor and repairs, do they lower the gain or not?

Customer :

I know the value of the house is what the exchange is based on what it is appraised at but my repairs, do I get to subtract them from the value of the house.

Robin D :

Repairs do not factor in at all only capital improvements. You can use the commission. Improvements add to your basis which lessen your gain. If you have a property that you got for $100,000 and you made improvements of $15,000 the the property is now worth $115,000. When you sale for $120,000 then you would only see a gain of $5000 instead of $20000. Now, in an exchange like you are contemplating (exchanging for a lessor valued property) you will be able to defer the gain but not all of it because you are accepting a property that is less than your own. You can not count repairs when you are adjusting basis even if it would help you to do so. Your basis in the replacement property will be the value of your replacement property less the amount of gain you deferred from the relinquished property. Since you would start as a negative if and when you sold the replacement property there would never be tax to be, this is why you can not exchange for a lesser valued property and n0t pay tax on the difference. It is loop hole that the tax code closed.

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