Is a Tax-Deferred Exchange Right for You?

Taxes on the disposition of real estate or other capital assets are paid on capital gain, not equity or profit. It is possible to sell property without realizing much profit and still owe substantial capital gains tax. Capital gain is simply the difference between the sales price and the adjusted basis (i.e., what you paid for the property, plus amounts spent on capital improvements, less depreciation taken) less any closing costs associated with the sale.

To calculate your estimated capital gain – first subtract the adjusted basis from the sales price; then subtract the costs of your transaction, commission, fees, transfer tax, etc.; finally, multiply the capital gain by your combined tax rates (Federal and State) to determine your estimated capital gain tax.

Hypothetical Example
1. Calculate Net Adjusted Basis
Original Purchase Price$400,000
Plus Capital Improvements$25,000
Minus Tax Depreciation Taken($175,000)
Equals Adjusted Basis$250,000
2. Calculate Capital Gain
Current Sales Price$600,000
Minus Sale Expenses($30,000)
Minus Adjusted Tax Basis($250,000)
Equals Capital Gain$320,000
3. Calculate Capital Gain Tax
Gain Attributable to Depreciation
($175,000 x 25% = depreciation)
Plus Federal Capital Gain Tax
($320,000-$175,000 = $145,000 x 20%)
Plus State Capital Gain Tax
(e.g. CA approx. 12.3% x $320,000 [cap. gain])
= Combined Tax Due$117,380
Maximum Deferral

To maximize the deferral of state and federal capital gain taxes, the Exchanger must reinvest all exchange proceeds and either acquire property with equal or greater debt or reinvest additional cash equal to the debt relief. The following worksheet is a useful tool for determining the amount of cash and debt that should go into the replacement property. 

Relinquished Property (Example)

Provides for a 50% increase in real estate purchasing power with an increase of leverage and no additional proceeds from Exchanger.

Sale Price:$400,000
Minus Existing Loans:$150,000
Minus Sale Expenses:$25,000
Equals Net Proceeds:$225,000
Replacement Property (Example to Maximize Deferred Taxes)
Purchase Price:$600,000
Minus New Loans:$375,000
Equals Minimum Down:$225,000

Note: Your minimum down payment for the replacement property should be equal to or greater than the net proceeds from the sale of your relinquished property. Otherwise, you may have “boot” in the form of cash.

The information provided above is a hypothetical example and is not tax advice. Consult with your tax advisor to determine the correct values and whether an exchange is appropriate for your circumstances.

Note: Failure to reinvest all your net proceeds and/or replace all your existing debt, may result in taxable “boot”. Additional equity (not derived from the replacement property) and/or additional debt can be used to offset debt but debt cannot be used to offset equity.

Under the Tax Cuts and Jobs Act (TCJA), capital gains tax rates are based upon the taxable income of the taxpayer and adjusted annually. For 2019, the capital gain tax brackets are (per Rev. Proc. 2018-57):

Long Term Capital Gains RateSingle TaxpayersMarried Filing JointHead of HouseholdMarried Filing Separately
0%Up to $39,375Up to $78,750Up to $52,750Up to $39,375
15%$39,376 - $434,550$78,751 - $488,850$52,751 - $461,700$39,376 - $244,425
20%Over $434,550Over $488,850Over $461,700Over $244,425

The tax information contained in this brochure is based on the current individual income tax code that is set to expire December 31, 2025. 

Plus, the 3.8% medicare surtax as follows: If your Adjusted Gross Income (AGI) is above the threshold amounts specified in IRC §1411, you will pay 3.8% surtax on either your net investment income or your excess AGI over the specified threshold – whichever is less. 

Single taxpayers with AGI over $200,000 and married taxpayers with AGI over $250,000 will be subject to the 3.8% surtax in addition to paying either 15% or 20% capital gains tax.