Tax Rules Affecting Real Estate Investors: Capital Gains & 1031 Exchanges

Brian Davis

Nothing is more certain then “death and taxes,” however many investors may not be aware of the new capital gains taxes affecting the real estate industry since 2012 and beyond.

The tax rate has now reverted from 15 percent to the former 20 percent capital gains tax rate. Investors selling second homes and investment properties, will incur a tax applied to the amount of gain realized if the income reported is over $200,000/$250,000 (filing individually or jointly).

If the increase doesn’t catch your attention, be aware there is also a second increase scheduled soon. Beginning in 2013, the national health care reform legislation enacted in March, 2010 imposes another 3.8 percent tax on single filers with incomes over $200,000 and married taxpayers with incomes over $250,000. The net effect of both equals 23.8 percent, the highest rate for long-term capital gains tax since 1997.

Real Estate 1031 Exchanges

The economic impact of these two tax increases may affect the very investors who help promote economic growth. However, there is a solution for smart investors, in the form of a 1031 tax-deferred exchange.

The Internal Revenue Service (IRS) on April 25, 1991 released a program: The Deferred Exchange Regulation-Reg 1.1031(k)-1, branded the IRC 1031 Exchange. What this means to a real estate investor is they can defer (put-off) capital gains taxes that come about from the sale of an investment property as long as the proceeds from that sale are used to buy one or more investment properties within 180 days of the close of the sale.

All purchases and sales must adhere to the specifications listed in the IRC 1031 Exchange guidelines. It is important to know that both properties must be held for use in a trade, business or for investment real estate. Properties used primarily for personal use, like a primary residence, second home or vacation home, do not qualify for the deferment.

Please note that the above description of a 1031 tax-deferred exchange is a brief overview, and serves only as an introduction. It’s highly recommended that all real estate investors consult an real estate accounting or tax law expert, and review the IRS's own overview of 1031 Exchanges (http://www.irs.gov/newsroom), as 1031 exchanges are extremely complex.

Landlord Tax Deductions

The key to getting the most bang for the buck from your deductions is keeping comprehensive records, says real estate and tax attorney Robert D. Lattas. Robert also based his comments on his experiences as a landlord.

Good records make it easy to see all the deductions you are entitled to take, and taking every one you're permitted allows you to significantly lower your taxable income for the year.

There are a number of deductions Robert itemized that every landlord should be sure they include when they file their federal return: