Unlike violinists, property investors must pay "trade-up" taxes. There are two main ways for an investor to be taxed when selling investment property:
Assessment or value increase (i.e. the property is sold for more than the investment) and
"Recovery" of the depreciation expenses the investor has borne during investment property ownership. While land cannot be depreciated, buildings may be so, when the investment is sold it can bear significant tax liability. Event
Immobilizing investors are not the only people who need to worry about taxes when selling property. Homeowners who sell more than invested their houses may also have a large tax bill. However, since homeowners cannot depreciate their homes, only capital gains tax is important to them.
Homeowners have relief not provided by property investors. If a person sells his primary residence, the first $250,000 in earnings is exempt from tax on capital gains. The exemption is $500,000 for a married couple who file together.
Like the 1031 exchange strategy in the future, homeowners can buy and sell primary residences and exempt 250,000 dollars from this profit for every sale. But only once every two years can they do this. Like real estate investors, heirs of homeowners will be strengthened when the homeowner dies.
Section 1031 History
When it first came into existence in 1921, an Exchange of Section 1031 required a literal exchange of both properties, as it would happen if my son were literally to trade in his small violin in the violin shop for a bigger violin. Tax deferment makes sense for a direct swap. "Sale prices" are often difficult to determine. Moreover, in contrast to a sale and reinvestment, a sale does not result in a cash payment that can be used to pay taxes.
But most people literally don't swap property. Rather, they sell one property and purchase another with the proceeds. Thus, Section 1031 exchanges have become more beneficial for real estate investors over the years.
The tax law has included safe haven in the last 30+ years if real estate investments are holding the property sales proceeds with a "qualified intermediary" until investors buy a new property. This is approximately the same as selling the smaller violin to a student, and putting the proceeds from the sale into a special account (such as a skilled intermediary) for a new violin only when the violinist has found the violin he wants to purchase.
Stepped Up Basis History
Instead of being linked to income taxes, such as Section 1031, this step-up is linked to estate taxes. The estate pays taxes on the total value of the estate of the decent on the risk of over-simplification. Therefore, when a real estate investor dies, property tax is 100% of the value (not just the capital gain or recaptured depreciation). Because property tax has been paid on 100 per cent of the value of the property, resetting the foundation of the heirs makes sense, which corresponds with the value at which property taxes have been paid.
But as a homeowner's $250,000 sale of his primary home is exempted from taxes on capital gains, the first part of a property is exempt from property taxes. This wasn't very important in the 1970s when the exemption from property tax was under $150,000. This exemption, however, gradually grew to $1 million in 2002. Then there was a huge jump to $5 million in 2010. The exemption increased enormously to $11.8 million in 2017, and to $11.7 million in 2021.
With such a large exemption from property tax, few properties pay any tax. And if property tax was not paid on the property, it certainly does not make that much sense. However, the exemption from estate tax was temporary and is expected to expire in 2025. If this happens, the step-up base will serve a logical purpose again.