When potential clients call to find out what the capital gains rate is, they usually think “oh, that’s not so bad”. What they fail to understand is that there are three tax hurdles to overcome on the sale of a capital asset.
The first hurdle is largely misunderstood and it can be very costly. Upon the sale of a capital asset, real property or personal property, previously taken depreciation deducted since May 6, 1997 to the date of sale is recaptured upon sale at the rate of 25%.
Capital gains tax, the second hurdle, is assessed at the rate of 15%. It is calculated based on the original cost-plus improvements less cost of sale against the sale price. This is usually the result of market appreciation and constitutes equity in the property. While the rate is not insurmountable, it is anticipated to be in excess of 20% in the not too distant future as Congress looks for revenue raisers.
The third hurdle depends on where you live and file your tax return, many states also tax capital gains at the state level and this can range from 3%-9%.
Unfortunately, too many taxpayers dutifully pay the tax each year without understanding that the tax can be deferred, interest free, if the sale is handled as a Section 1031 Exchange. Every taxpayer regardless of whether that taxpayer is an entity or individual, as long as the property is not personal use property, can utilize exchanges as a tax deferral strategy and never pay the tax!