In 2003, Congress set the top tax rates for both capital gains and dividends at 15 percent, lower than they’d been since the 1930s. Under the current tax plan, the top capital gains would be taxed at 20 percent, not including the 3.8 percent associated with the Affordable Care Act, which is a 33.3 percent increase. So now’s the time to better understand the strategies available to maximize your investments.
Of course, it’s never a bad time to be rich. But it’s a worse time to be rich now because the new tax plan has clearly stated that the wealthier Americans will shoulder a bigger burden of the federal tax revenue. Despite these tax increases, one aspect of the tax code provides real estate investors with a huge tax advantage. A Section 1031 exchange allows real estate property owners holding property for investment purposes to defer taxes that would otherwise be incurred upon the sale of investment property.
Savvy investors use 1031 exchanges to redeploy their investment capital into better-performing investment properties while deferring capital gains taxes. The logistics and process of selling a property and then buying another are similar to any standardized purchase and sale, but a 1031 exchange is unique because the entire transaction is treated as a tax-deferred exchange and not just a simple sale. It’s this difference between “exchanging” and not simply buying and selling which, in the end, allows the taxpayer to qualify for a deferred gain treatment.
To say it in simple terms, sales are taxable with the IRS and 1031 exchanges are not, unless consideration is received or debt is relieved. It’s critical to remember that the capital gains taxes are only deferred and not eliminated when completing a 1031 exchange.
The foundation of a 1031 exchange by the IRS is that the properties involved in the transaction must be of “like kind,” and both properties must be held for a productive purpose in business or trade, or as an investment. The IRS also lays down a guideline for the proceeds of the sale. For example, the proceeds from the sale must go through the hands of a “qualified intermediary” (QI) and not through the sellers or their agent or the proceeds will become taxable.
Because the exchanging of a property represents an IRS-recognized approach to the deferral of capital gain taxes, it’s very important to understand the many components involved and the actual intent underlying such a tax-deferred transaction. It’s also worth noting there are several very specific conditions one must comply with to complete a successful 1031 exchange. This includes the 45-day identification period, 180-day exchange period, and the purchase price of the exchange property must be of equal or greater value, just to name a few.
As mentioned earlier, self-storage owners are also allowed under the current tax code to use cost segregation to maximize the timing and amount of depreciation an owner can achieve to shield ordinary income from income tax. Accelerated depreciation has many details you must follow to successfully use this part of the tax code. The use of cost segregation to achieve accelerated depreciation is also simply a deferral of taxes and not a loophole that allows you to avoid paying taxes.
As investors in real estate, self-storage owners must continue to understand the ever changing rules that will allow them to maximize the return on their investments. They also must continue to seek the necessary experts in the industry who will help them develop the required strategies needed to navigate the evolving real estate investment world.
Ben Vestal is president of the Argus Self Storage Sales Network, a national network of real estate brokers who specialize in self-storage. Argus provides brokerage, consulting and marketing services to self storage buyers and sellers and operates SelfStorage.com, a marketing medium and information resource for facility owners. For more information, call 800.55.STORE; e-mail firstname.lastname@example.org. To learn more about cost segregation and accelerated depreciation, visit www.argus-selfstorage.com .