Many people just assume that they need to do a Section 1031 like kind exchange in order to save on their taxes.  This decision may be premature if the taxpayers haven't had their professional tax advisors run the numbers to see if an outright sale would in fact cost them anything in taxes.

I have seen many cases where people assumed that a sale would result in taxes, when in fact that wasn't the case.  Here are some of the most common reasons that a sale may not cost any actual taxes, starting with a new one that is just now starting to show up on tax returns.

Special Zero Percent Capital Gains Tax - For 2008, 2009 and 2010 sales by individuals, all or part of any long term capital gain is subject to a Federal tax rate of zero percent.  The actual calculation of this is rather complicated and should be handled by your professional tax advisor's tax software.

While this has the potential to save large amounts of taxes and thus make doing a 1031 exchange unnecessary, there are some other factors to consider.

This is for Federal purposes only and most states have not gone along with this; so there could still be State taxes on a sale.

This only applies to the long term capital gain portion of a sale.  It does not apply to short term capital gains for assets held less than 12 months.  It also does not apply to gain attributable to depreciation recapture, which is still subject to a 25% Federal tax rate plus the State tax rate.

The other key consideration is the political environment.  The new president said during his campaign that he wanted to eliminate any special tax breaks for capital gains and make them subject to the same much higher tax rates for other kinds of income.  He said that he is will aware that this will reduce the government's revenues from capital gain taxes as more people take steps to avoid paying them; but he sees it as the Fair thing to do.  He can't do anything to affect the tax on 2008 sales, but he could repeal the special tax break for 2009 and/or 2010 sales as he has been promising/threatening to do.

Loss Carry-forwards - Many people have large losses that they have been carrying forward for several years on their tax returns that can be used to offset gains from the sales of business and investment properties. These carryover losses include Capital Losses, Net Operating Losses and Passive Activity Losses.  There should be some kind of schedule with your latest tax return showing how much of these kinds of losses are being carried over into the current tax year. Similarly, your professional tax preparers should have those losses already set up in their tax return software when running proforma tax calculations of a possible sale.

Basis Mistakes - To determine whether you have a gain or loss on a sale, it is critical to understand the proper cost basis to use for the asset.  One of the most common mistakes has to do with inherited property. The cost basis for the heir is the asset's fair market value at the time of the previous owner's death.  This means that an inherited asset being sold shortly after it has been received will normally result in no gain, and possibly even a loss after deducting selling costs.  Doing a 1031 exchange only makes sense if there is a profit to defer.

On the flip side, the other common basis mistake has to do with items received as gifts from living persons.  In those cases, the cost basis to the recipient is the same as it was for the giver.  While the actual receipt of a gift is tax free for the recipient, recipients are essentially accepting responsibility for future capital gain taxes on it.  It is important that the giver provides the cost basis info to the recipient along with the gift.


As always, no tax oriented transaction, especially dealing with capital gains and 1031 exchanges, should be attempted before the numbers have been run by your professional tax advisor. Any fees they charge will be minimal compared to the potential tax savings.

Labels: CapGains

- posted by Kerry M. Kerstetter, MBA~CPA~ATP~ATA @ 2/15/2009 04:56:00 PM Send this post: