Calculating Immediate Tax Savings

It is wise to determine the amount of your capital gain or loss prior to the sale of your investment property.  In fact, the earlier you determine the amount of your gain or loss, the better prepared you will be to structure the transaction to your maximum benefit.  If you have a capital gain and you plan to acquire “like-kind property” that will also be held for investment, you may wish to consider a §1031 tax-deferred exchange to defer the gain and build your wealth.


Calculating the amount of your capital gain or loss is not as difficult as it may seem.  While there are several steps to the calculation, the most difficult part is ensuring that you are using the correct numbers.  As the saying goes, “the devil is in the details.”  


A simplified formula for calculating the amount of your capital gain or loss is set forth below.  Let’s assume the following scenario: 

Step 1:



Step 2:


Calculate your net adjusted basis :


Calculate your capital gain or loss:






Original Purchase Price



Sales Price


Plus Improvements



Minus Net Adjusted Basis


Minus Depreciation



Minus Costs of Sale








Let’s assume that you have a capital gain as shown above.  This will result in an immediate tax liability.  Instead, consider deferring your taxes by participating in a §1031 exchange.  To determine the amount of the taxes you may defer, there are just a few more calculations to be performed (the following tax calculation is based upon the above scenario and an assumed state tax rate of 5%):

Depreciation Recapture Tax[i]


Plus Federal Tax (max. tax rate of 20%)


Plus State Tax (enter applicable tax rate)


Plus 3.8% Medicare Tax





While your calculation will provide you with a better understanding of your potential tax consequences, we recommend that you consult with your accountant or tax advisor.  Your accountant can verify the accuracy of your calculations, advise you if a §1031 exchange is appropriate for your transaction and, if it is, help you to structure it to your maximum benefit.

If you decide that a §1031 exchange is right for you, then there are other important tax issues to consider.  Some believe that simply by participating in a §1031 exchange all capital gain tax will be deferred.  Others believe that in order to participate in a §1031 exchange, all sales proceeds must be re-invested in one or several replacement properties.  Neither of these beliefs is entirely true.  Let’s examine the issues further:

In order to have a fully deferred exchange, you must meet the following requirements:

  1. Acquire property of equal or greater value than the relinquished property.  Example:  You sell an apartment building for $750,000 and acquire an office building for $750,000, or more.
  2.  Be sure that your equity[ii] in the replacement property is equal to or greater than the amount of equity that was in the relinquished property.  Example:  The debt on the apartment building was $350,000, resulting in equity of $400,000.  To maintain the same equity, the debt on the office building should be no greater than $350,000. However, you can increase your equity without causing a taxable event.  Let’s say that you have $100,000 on deposit in a money market account and you know that the rate of return on your deposit is far less than the interest rate you will pay on your loan.  So, instead of taking out a loan for $350,000, you decide to invest your $100,000 and reduce the amount of your loan to $250,000 and increase your equity to $500,000.
  3. Avoid receiving any non like-kind property, primary examples of which are directly receiving cash or a Promissory Note from the buyer of the relinquished property.


What if you want to participate in a §1031 exchange to defer some of your taxes but you cannot or do not wish to meet all of the above requirements? Can you do it? Yes, you can. Perhaps you want to take some of the cash from your sale to pay bills or to take a vacation. You can elect to receive some of the cash; however, you will create tax consequences. You will then have a partially deferred exchange and it will be especially important to determine if a §1031 exchange still makes economic sense. Consult with your tax advisor to consider the amount of fees and costs that you will incur in connection with the 1031 exchange versus the amount of taxes that you will defer.


If you would like additional information about the benefits of a 1031 exchange, call your First American Exchange representative.  



[i] If the property that you are selling is 1) improved; 2) being sold at a gain; and 3) you have taken depreciation deductions, then you may be required to pay tax on the amount of depreciation taken, generally at a rate of 25% for real property.


[ii] Equity is the Fair Market Value minus Debt (e.g. $750,000 - $350,000 = $400,000 of equity). Be careful not to increase the debt on the replacement property unless you are purchasing for a higher value. If you have less equity in the replacement property, you will have “cashed out” to that extent, which may result in taxable boot.