If you owned investment property before 1986, you know how advantageous real estate once was as a tax shelter. The tax code has since changed considerably, but there are still some unique tax features of real estate that—when combined strategically over time—have the potential to produce significant financial benefits.

Categorically, these advantages are:

  • Depreciation,
  • 1031 Exchanges, and
  • Step-up in Basis

These strategies help mitigate the tax consequences of leasing, trading and bequeathing real estate, respectively. Used together, they have the potential to eliminate most of your rental income tax and all your tax on gains:

DEPRECIATION

The tax code allows you to deduct the notional depreciation of your real estate, every year, against your rental income. For most owners, the annual cap on this deduction is between 2.5 and 3.6% of the value of your improvements (i.e., the structures on top of the land). Once these deductions add up to the original value of the improvements, they stop—unless you have since added more improvements to the property.

For owners in high tax brackets, depreciation deductions can reduce annual taxes by tens or hundreds of thousands of dollars. But there is a catch. When the property is sold, all of the prior cumulative depreciation is “recaptured” by the IRS at a tax rate that is not much lower than the original income tax that was avoided.

Unless, of course, you sell your property as part of a…

1031 EXCHANGE

A complete 1031 exchange potentially allows you to sell one investment property and buy another, without recognizing any taxable gain. You are able to defer both the capital-gain tax on your appreciation and the recapture tax on your depreciation.

More importantly, you can execute this strategy an unlimited number of times over your life, repeatedly kicking a larger and larger tax can down the proverbial road.

Under recent Congressional action, now only real estate (as opposed to cattle or cranes or airplanes) can be sold in a 1031 exchange. And if you are already in a transaction today (date here), your identification or closing period under IRC Sec. 1031 could be extended under a presidential decree issued April 9 (check with your tax professional for details).

Finally, upon your passing, your heirs get a…

STEP-UP IN BASIS

Yes, you do have to die for someone to benefit from this last strategy, but the positive tax consequences are among the highest in the entire tax code.

In almost all circumstances, the “cost basis” of your real estate is “stepped up” on the date of your death to its fair market value. This effectively means that all capital-gains and depreciation-recapture taxes payable if you had sold—rather than died—on that day are wiped away.

If your heirs keep your property for any length of time before selling, they would owe some taxes, but only relating back to the value of the property upon your passing.

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As with anything tax-related, the devil is in the details, and you should always work with tax and investment professionals who are well-versed in the relevant rules and regulations.

For more information, please contact 1031 Capital Solutions at (800) 445-5908 or visit our website, 1031CapitalSolutions.com.

This information is for educational purposes only and does not constitute direct investment advice or a direct offer to buy or sell an investment, and is not to be interpreted as tax or legal advice. Please speak with your own tax and legal advisors for advice/guidance regarding your particular situation. Because investor situations and objectives vary, this information is not intended to indicate suitability for any particular investor. The views of this material are those solely of the author and do not necessarily represent the views of their affiliates.

Investing in real estate and 1031 exchange replacement properties may involve significant risks. These risks include, but are not limited to, lack of liquidity, limited transferability, conflicts of interest, loss of entire investment principal, declining market values, tenant vacancies, and real estate fluctuations based upon a number of factors, which may include changes in interest rates, laws, operating expenses, insurance costs and tenant turnover. Investors should also understand all fees associated with a particular investment and how those fees could affect the overall performance of the investment.

Securities offered through Concorde Investment Services, LLC (CIS), member FINRA/SIPC. Advisory services offered through Concorde Asset Management, LLC (CAM), an SEC registered investment adviser. Insurance products offered through Concorde Insurance Agency, Inc. (CIA). 1031 Capital Solutions is independent of CIS, CAM and CIA.