Nashville on the Move


	1031 Exchanges The opportunity to protect hard earned equity in the sale of an investment has been available to consumers since 1921. However, complexities and details of the tax code prevented only the most knowledgeable from using this option. In 1990 the Omnibus Budget Act clarified the process an opened this option to a broader set of consumers. Section 1031 Exchanges, which have become more popular since the mid-90s, allow investors to defer the tax on capital gains until some point in the future. Section 1031 of the Internal Revenue Code provides that no gain or loss shall be recognized on the exchange of property held for productive use in a trade or business, or for investment. A tax-deferred exchange is a method by which a property owner trades one or more relinquished properties for one or more replacement properties of "like-kind", while deferring the payment of federal income taxes and some state taxes on the transaction. The theory behind Section 1031 is that when a property owner has reinvested the sale proceeds into another property, the economic gain has not been realized in a way that generates funds to pay any tax. In other words, the taxpayer's investment is still the same, only the form has changed (e.g. vacant land exchanged for apartment building). Therefore, it would be unfair to force the taxpayer to pay tax on a "paper" gain. The like-kind exchange under Section 1031 is tax-deferred, not tax-free. When the replacement property is ultimately sold (not as part of another exchange), the original deferred gain, plus any additional gain realized since the purchase of the replacement property, is subject to tax. Capital Gains When you sell a stock, you owe taxes on your gain — the difference between what you paid for the stock and what you sold it for. The same holds true when selling a home (or a second home), but there are some special considerations. How to Calculate Gain In real estate, capital gains are based not on what you paid for the home, but on its adjusted cost basis. To calculate, follow these steps: 1. Purchase price: _______________________ The purchase price of the home is the sale price, not the amount of money you actually contributed at closing. 2. Total adjustments: _ ______________________ To calculate this, add the following: Cost of the purchase — including transfer fees, attorney fees, and inspections, but not points you paid on your mortgage. Cost of sale — including inspections, attorney fees, real estate commission, and money you spent to fix up your home just prior to sale. Cost of improvements — including room additions, deck, etc. Note here that improvements do not include repairing or replacing something already there, such as putting on a new roof or buying a new furnace. 3. Your home's adjusted cost basis: _ ______________________ The total of your purchase price and adjustments is the adjusted cost basis of your home. 4. Your capital gain: _ ______________________ Subtract the adjusted cost basis from the amount your home sells for to get your capital gain. A Special Real Estate Exemption for Capital Gains Since 1997, up to $250,000 in capital gains ($500,000 for a married couple) on the sale of a home is exempt from taxation if you meet the following criteria: You have lived in the home as your principal residence for two out of the last five years. You have not sold or exchanged another home during the two years preceding the sale. You meet what the IRS calls “unforeseen circumstances,” such as job loss, divorce, or family medical emergency The links below can provide additional information on real estate tax laws. www.comptroller.state.tn.us www.irs.gov