Learn the Secret of 1031 Exchanges

Are you tired of capital gains taxes leeching away your profit margin? Discovering the secret of 1031 exchanges will allow you to increase the profits on your real estate investments by avoiding paying these taxes. Best of all, you can accomplish this legally! These transactions are known as 1031 exchanges because, to legally avoid capital gains taxes, or sharing profits with the federal government, investors must meet every condition listed in Section 1031 of the Internal Revenue Code. Because these requirements are quite complicated, wise real estate investors will use an accountant, and possibly a tax attorney, as well, to review each sell to make sure that it complies with these conditions.

Although the stipulations are quite detailed, the process is simple for even a new investor to understand. To comply, you must first make a sale. Identify an agent, known as the intermediary or accommodator, which will help you make the exchange. Within 45 days after closing, you must identify another property for which you wish to make the exchange transaction. Be aware, however, that the transaction for this property must be completed within six months. In addition, all of the proceeds from the first sale must be used to make the second purchase.

The property purchased must be valued as highly or more highly than the first. Finally, the investor must hold at least as much debt against the second property as he or she did against the first. If you want to be a savvy real estate investor, you will quickly learn the secrets of 1031 exchanges. You can continue to use these tax-free changes until you stop exchanging properties for investment. If you plan properly, you should never have to worry about paying these taxes. Keep the profits from your real estate investments for yourself; stop donating them to Uncle Sam!

Capital Gains Exclusion

The Taxpayer Relief Act 1997 allows the homeowner to profit without paying tax on the sale of the property. The single homeowners are allow to profit up to $250,000 without paying tax, while the married homeowners are allow to profit up to $500,000 without paying tax.

Before May 7, 1997, the only way not to pay tax on capital gains is to use the capital gains to acquire another property. These homeowner tax breaks come as a surprise and relief for many homeowners. Now, the capital gains are tax exempt as long the sale comes after the law took affect.

There is no limit of the use of the Capital Gains Exclusion. The homeowners are able to avail as many times as possible.

However, the sold home must be a principal residence. That means the homeowner must have live at least two of five years on the sold home. It does not have to be sequence as long as the total comes over two years.

For any rental property, it can easily convert into principal residence. Suppose the homeowner decides to live on the rental property, the homeowner needs to stay at least two years on the rental property.

The home property does not have to be principal residence at the time of sale. So, the homeowner can rent out the property a few months before the sale of home property.

The married homeowner does not have to live on the same time. For example, the bride got married after a year and three month of living on the home. In nine months, the married homeowners can be tax exempted from capital gains.

Additionally, one of the married homeowner did not use the Capital Gains Exclusion within two years of sale. For example, the bride sold her home to live with groom. The bride used the capital gains exclusion. So, the bride and groom can only use the Capital Gains Exclusion after two years.

For special reasons, the homeowner can prorate the capital gains exclusion on health, employment, and unforeseen circumstances. For example, a heart attack may force a homeowner to sell before two years. Suppose the homeowner lived for twelve months, the homeowner is tax exempted for twelve / twenty four months portion of capital gains.

A great job offer comes along. The homeowner needs to move. For the homeowner to move, the homeowner needs to sell the home. The homeowner can also prorate the capital gains.

The unforeseen circumstances are national disaster, war, terrorism, death, divorce, separation, and multiple births.

The capital improvements increases the home values. As the home values increase, the capital gains also increase. You may worry how much tax that you have to pay. The Capital Gains Exclusion may well save you taxes. For the latest tax laws, you may want to get in touch with IRS, or tax advisors.

Amendments to Cyprus Tax Legislation

INTRODUCTION

The Cyprus Parliament has voted on the 14th of December 2010 certain amendments to the following Cyprus tax laws:
Income Tax Law
Special Defense Contribution Law
The Assessments and Collection of Taxes Law
Capital Gains Tax Law
Immovable Property Tax Law
Value Added Tax Law

These will be put in effect 6 months after the publication of such laws in the Official Gazette of the Republic.

INCOME TAX LAW

(a) Disallowed expenditure:

Any expenditure not supported by invoice or corresponding receipts or other supporting information will not be treated as deductible expenses for income tax purposes.

(b) Tax withheld on payments to non-Cyprus residents:

Tax withheld on payments to non-Cyprus residents should be paid to the Income Tax authorities by the end of the following month. If the tax is not paid within the deadline, an additional tax of 5% will be imposed on the tax withheld in addition to the interest imposed (today at 5%). Such payments must be paid in respect to the following:
Copyrights for use within Cyprus at 10%;
Rights for cinematographic films at 5%;
Income of a physical person in respect to professional services, fees of artists and athletes at 10%.

(c) Notional interest on receivables from shareholders or directors:

Notional interest, according to section 39 of Income Tax Law, will only be imposed on debit balances or loans to shareholders or directors at the rate of 9%. If the shareholder is a company, then market rate of interest will apply as per related party transactions.

SPECIAL DEFENSE CONTRIBUTION LAW

(a) Deemed dividend distribution:

In the case of non-payment of dividends by a company within two years from the end of the financial year, the provisions of deemed dividend distribution apply where 70% of profits, after tax is deducted, is deemed to be distributed to the shareholders of the company as dividends and special defense contribution is payable at the rate of 15%.

In the case where a company disposes an asset to its shareholder (physical person not legal) for a consideration which is below the market value of the asset disposed, it will be deemed that the company has distributed dividend to its shareholder equal to the difference between the market value of the asset and the amount of the consideration. In such a case, special defense contribution is also payable at the rate of 15%.

It should be noted that the provisions of the law for deemed dividend distribution will not apply where the shareholders are not tax residents in Cyprus.

(b) Definition of "Taxation":

The definition of "Taxation" has been amended for the purpose of calculating a company' profit that is subject to special defense contribution to include the following:
Special defense contribution
Capital gains tax
Any tax paid abroad which has not been credited against the income tax and or special defense tax payable for the relevant year

(c) Capital Reduction:

Where the capital of the company is reduced, any amounts paid to the shareholders of the company in excess of the amount of the share capital that was actually paid by the shareholder will be treated as deemed dividend taxable at 15%.

(d) Voluntary Liquidation:

In the case of a company under voluntary liquidation, a deemed dividend declaration will need to be submitted (within one month from the date of the resolution for liquidation) to the relevant authorities in respect to profits of the specific year and the two preceding years.

ASSESSMENT AND COLLECTION OF TAXES LAW

(a) Registration with the Income Tax office:

Companies have an obligation to register with the Inland Revenue Department and obtain a tax identification code within 60 days from the date of its incorporation with the Registrar of Companies in Cyprus.

(b) Banking Secrecy

The Commissioner of Income Tax has the right to request from a bank to provide information in the bank's possession for a period of seven years from the date of such request. Such power can only be used provided that there is a written approval by the Attorney General of the Republic. As such, specific requirements need to be fulfilled by the Commissioner prior to receiving such approval.

(c) Submission of Tax Returns, Tax Assessments and Objections:
Provisions have been introduced for the submission of electronic tax returns where these have been prepared by a professional auditor. The deadline for submission in the case of electronically submitted returns is extended by three months.
Where a person (individual or company) omits to submit a tax return within the time limit set out in the Law and if the Commissioner decides that such a person has an obligation to pay taxes, then the Commissioner can proceed with the issuance of tax assessment for that person based on the information available.
Any objection submitted against a tax assessment referred to above should provide for the reasons that the assessment is incorrect, the reasons that he considers that no obligation to pay the said tax arises and provide supporting documentation. Such objection should be effected within one month from such assessment.
The Commissioner has the right to request information from any civil servant to provide details in relation to any person for tax purposes.
Companies which have an obligation to keep books and records for every tax year are obliged to update them within four months from the date of the transactions. Further, companies are required to issue invoices within 30 days from the date of the transaction unless a written approval has been obtained by the Commissioner.

CAPITAL GAINS TAX & IMMOVABLE PROPERTY TAX

Administrative penalties equal to EUR 100 or EUR 200 will be imposed for late submission of declarations or supporting documentation requested by the Commissioner of Income Tax. In the case of late payment of capital gains or immovable property tax due, an additional tax of 5% will be imposed on the unpaid tax.

VALUE ADDED TAX

The zero tax rate applicable to foodstuff, pharmaceutical products and vaccines has been increased to 5%. Such amendments are in effect as from 10-01-2011.

Business Incorporation and Disincorporation

Incorporation and disincorporation are two key decisions to be made at different times in a business life cycle. This article covers the merits of each.

Should I incorporate?

There are too many different permutations of income and individual circumstances to be definite as to which structure is better.

You need to do the projections for both structures. Losses are more effectively utilised when a sole trader and usually it is better to start as a sole trader. Then, once into profit, incorporate to gain the commercial protection offered to the owner by the limited status.

There are income tax advantages to higher rate taxpayers together with national insurance savings.

Transfer of business to a limited company

If you decide to transfer your business to a company:-

Your sole trade will cease on the date of transfer.

The trading stock will be transferred at market value subject to you being able to elect to substitute the greater of cost or the price paid by the company if that would give a lower figure.
Similarly the cessation will give rise to a balancing charge or allowance but you can elect within two years to transfer the assets at tax written down value.
Any unused trading losses cannot be transferred to the company but you can relieve them against income received from the company e.g. salary, fees or dividends.
The chargeable assets of your trade that are transferred to the company give rise to capital gains tax. The computation of liability can be made in either of two ways. (Sections 162 and 165 TCGA 1992).
Stamp duty must be considered; it is not payable on stock, plant or goodwill but SDLT is payable on any transfer of the premises.

You will need to consider whether the company should be registered for VAT and whether the business is to be transferred as a going concern.

Should I disincorporate?

Trading stock

If the trade goes back to the original shareholders and as they are connected with the company, the stock will be transferred at market value. This is subject to an election to substitute the actual transfer value.

Capital Allowances

Balancing adjustments will need to be made taking the actual value at transfer again subject to the election to transfer at the tax written down value.

VAT

There should be no trouble as the transfer will be of a going concern.

Assets

These will give rise to the biggest problem. Substantial capital gains could arise and this will need careful attention with the appropriate professional advice.

Trade ceases

If it is decided to disincorporate, for corporation tax, the trade is treated as ceasing even though the actual trade may continue.

Accounting date

The accounting date ends on the date of disincorporation.

Losses

Unlike when a business is incorporated where any losses are carried forward, on disincorporation any losses are "lost."

The IRS Giveth and the IRS Taketh Away

If you haven't noticed a pattern yet, when tax law changes to benefit one segment of the population (resulting in a loss of revenue to the IRS), there is usually some other change that reduces benefits to a different population segment, thus making up for the former loss.

Such is exactly what will happen if pending legislation passes into law.

HR 3648, or the Mortgage Cancellation Tax Relief Act, passed the House of Representatives Oct. 4, 2007 and is up for consideration in the Senate. If the bill becomes law, its tighter restrictions may require a new strategy for some investors.

Here is the gist in layman's terms of what this might mean to the average investor.

If you are in danger of foreclosure on your existing mortgage, a buyer may make a deal with your lender to purchase your home for less than what you owe. You are "forgiven" the difference from the lender, but under current tax law you must declare this forgiven amount as income on your tax return and pay income tax on money you don't have. If you are already having trouble making mortgage payments, you often have trouble coming up with this extra tax payment and you are back to square one.

HR 3648 would exempt you from having to declare this as income in this situation. That's the good news, but that's a lot of money the IRS would be losing.

So, in order to save those with mortgage issues, the proposal is to tighten the rules for taking some personal exclusions on primary residences. Currently, if you own and live in your home for at least 2 of the last 5 years, you are allowed a personal exclusion of 250K if single and 500K if married filing jointly for capital gain when you sell.

What patient and savvy planners have been doing is selling their primary residences, taking the exclusion and moving into their appreciated second home or investment property for 2 years and then selling it and taking another exclusion to once again avoid capital gains tax.

What HR 3648 will do is limit the amount of exclusion available to you to the gain accrued only during the time you reside in that second property. So, if the property had increased in value by 300K prior to you moving in, then another 100K in the 2 years you resided in it, your exclusion would be limited to 100K when you sold and not the currently allowed 400K total gain (if married).

As with any tax law, if you are in neither of these situations you probably could care less. If you fall into the second category you will need a "plan B" to minimize your capital gains. Just be aware that laws constantly change and what is true today may be obsolete tomorrow. It's a full time job just keeping up!

Year-End Tax Tips for Investments

Yes, its that time of year again, time for every financial column to drum into your head all the year-end investing tax tips. It's the equivalent of your list to Santa. You either take care of it by year-end or you take your chances. Consider yourself warned.

Take Your Losses - Losses are never a thing of beauty, but they can become palatable at this time of year. Even if you're convinced that the paper loss is only a temporary situation, you should still consider selling. You can buy the position back in 31 days to avoid what's called a "wash sale."

Netted out against long-term capital gains, you can claim $3,000 of long-term capital losses on your current income tax return, with the remainder being carried forward into future years.

Check With Your Mutual Funds for Long Term Capital Gain Distributions - Many Mutual Funds make long-term capital gain distributions before the end of the year. Even if you reinvest them back into the mutual fund, they are still taxable distributions. By calling the mutual fund company (or your broker), you should be able to get at least an estimate of what those distributions will be.

If there are distributions, go back and read the tip about losses.

Defer Capital Gains - If you can defer taking your capital gains until January, do it. If you take them today, the tax will be due April 16th, 2007. If you wait until January, the tax won't be due until April 15th, 2008. You decide.

Maximize Your 401(k) Contribution - You know this was a New Year's Resolution last year! December 31st is the final day to make good on it.

Fulfill Charitable Pledges With Low Tax-Basis Stock - Why give cash when you can siphon off some of that ExxonMobil you've owned for 20 years? You can claim a deduction for its full value - not simply what you paid for it - and avoid the capital gains tax as well.

Of course if you're thinking about giving away stock with a tax basis higher than its current market value, think again. Here, you're better off selling the stock, taking the loss, then giving away the cash.

Donate To Charities Directly From Your IRA - New Law Alert! In the years 2006 and 2007, you can donate up to $100,000 to your favorite charity directly from your IRA. This is only available to those individuals who are at least 70 ½ years of age.

If 70 ½ Or Older Make Sure You've Made The Required Minimum Distribution From Your IRA - Distributions from Individual Retirement Accounts (IRAs) must be made by year end. Make sure you've included all your accounts in calculating your minimum distribution. Mistakes can often occur if you transferred IRA accounts during the year.

Remember That The End of One Year Is The Beginning of A New Year - Tax planning and investing are year-round activities. As you move into the new year, make a list of things to do early in the year. Increase your 401(k) contribution or start a systematic investment program. Leaving it all to the end of the year can put a dent in both your cash flow and your holiday cheer.

Preparing Income Taxes - Why You Need to Know About Capital Assets

The IRS is in the business of collecting revenue to support our government. It collects taxes on various forms of money we "accumulate". We are taxed on income we earn; on interest we receive on savings, on dividends from stock we own, and from gains or losses from the sale of our possessions. The IRS Tax Code often categorizes these possessions using negative definitions. It is very confusing! According to the IRS, "our stuff" might belong to some category of property UNLESS it is listed as an exception to that category! For example, in IRS-speak, capital assets are defined as any property that is not explicitly listed as an exception! Sounds crazy (or deviously clever)? Let's start with that negative definition...

Some stuff is real and some stuff is personal. Real stuff is typically associated with "dirt"; like real estate, buildings, or just land. Personal stuff is anything that is not real! Personal property is "movable". Your car, your refrigerator, and your lawn mower are stuff you can hold, move, or break. This "stuff" or property is tangible; it has "substance" and usually some intrinsic value. You can also have intangible property like pieces of paper called stocks and bonds. The value of the "paper" is in the rights of ownership it conveys; they are examples of intangible personal property.

Thus, almost all the "stuff" you own for personal or investment use is a capital asset. Your car, your refrigerator, your lawn mower are examples of personal-use property. The definition begins to blur though because while your home is real, personal use property, a rental home that is not your residence would be business-use property. That rental is maintained to produce some form of income. It might also be considered investment-use property because it has the potential to increase in value over time.

But there is an even more important classification the IRS relies on to collect revenue: holding period. When "stuff" is owed for periods of time that exceed 12 months and a day, the gain or loss from the sale of that property is classified as long-term rather than short-term. The net capital gain is the difference between more preferably long-term gains (or losses) over short-term gains (or losses). The tangible "stuff" you use for non-business or personal reasons is called a capital asset. When you sell this kind of "stuff", any profit or amount over the "original cost" is considered a capital gain and, most important, is taxable. You are required by law to report a capital gain on your income tax return. Depending upon the size of a capital gain, you might also need to make an estimated tax payment! You calculate the gains or losses on Form 1040, Schedule D, Capital Gains and Losses and transfer the net amount to Line 13 in the income section on the top page of your IRS Form 1040. You can find out more information on the IRS website, IRS.gov.

The Best Investments For Taxable Accounts - Part II

As discussed in Part I of this article, investors in the U.S. will face significantly higher levels of taxation on all forms of income and capital gains beginning in 2011. As a result, investors in the higher marginal tax brackets and those having substantial taxable investments may wish to explore investment opportunities and portfolio strategies that seek to reduce their tax liabilities. There are two broad categories of investment with some sort of tax preference: tax advantaged and tax deferred. Now let's explore a handful of specific investments, or investment cash flows that might be beneficial to investors concerned with the future tax regime.

Municipal Bonds: Municipal bonds are perhaps the most well-known tax advantaged security available to investors. Generally speaking, interest earned on municipal bonds is exempt from federal income tax, and may be exempt from state and local government taxes as well. Furthermore, long-term municipal bonds have historically traded at market yields that are even high than what their tax-equivalent yields should be, potentially providing additional return to the investor. It should be noted that any capital gains associated with municipal bonds are not exempt from taxation, but are instead subject to the same tax rate as other marketable securities. Finally, some municipal bonds are subject to the Alternative Minimum Tax, so investors need to be selective and ensure that they understand what types of bonds they own.

Master Limited Partnerships: A master limited partnership (MLP) is a publicly-traded partnership structure that may be elected by firms that earn greater than 90% of their income through operations and assets relating to natural resources, commodities or real estate. As a result, most of the MLPs available to investors own and operate assets such as oil pipelines, gas pipelines, treatment and processing facilities, propane distribution systems, etc. To an MLP shareholder (technically called a unit holder) the benefit derives from the fact that limited partnerships have pass-through taxation and thus there is no tax paid by the MLP itself, but the tax liabilities are passed on to the unit holders. Thus, MLPs avoid the double-taxation associated with corporations. Importantly, investors in MLPs receive cash distributions that are not taxed when received, but are classified as reductions in cost basis and therefore the investor generally owes very little taxes until the MLP is ultimately sold. Thus, investors may be able to earn very attractive cash yields and defer the tax liability for many years.

Qualified Dividends: Qualified dividends (as opposed to ordinary dividends) are taxed at lower capital gains tax rates, rather than marginal income tax rates. Most equity dividends are considered to be qualified, and therefore there is a significant tax advantage for investors who receive qualified stock dividends versus income from other sources, such as CDs or corporate bonds. So on a tax-adjusted basis investors may actually be able to earn higher cash yields on equities than on fixed income investments in the current era of low interest rates.

Equities (if held long-term): Long-term capital gains tax rates are applied to any gains generated from the ownership of an asset for more than one year. So, if you own a stock for more than 1 year you will pay a tax rate on any gain that may be less than half of your marginal income tax rate. Also, capital gains taxes are only paid once the gain is recognized, so an investor can both lower and defer their tax liability associated with stock ownership for many years. This long-term capital gains treatment applies to fixed income securities as well but for most investors any capital gains from bond investments are likely to be small in comparison to the income earned on those bonds, which is of course taxed at the much higher prevailing income tax rates.

Precious metals: The tax treatment of gold and other precious metals is somewhat complicated and varies depending on the method of investment. For assets in taxable accounts the most efficient way to gain exposure to precious metals is through ownership of equities of gold mining companies, in which case you would apply the aforementioned stock and dividend tax rules, as mining stocks are treated just as any other stock investment for tax purposes. You might also consider owning a precious metal ETF, but these funds and others like them are treated as "collectibles" by the IRS and are therefore taxed at a 28% capital gains tax rate, which is one of the highest capital gains tax rates among all investable assets. Of course, if you have a very long time horizon you will defer the payment of the tax liability indefinitely, as gold provides no short-term cash flows such as interest or dividends, therefore creating no liability for as long as you hold the investment.

It should be understood that this article does not cover all of the possible tax consequences resulting from investment in any of the securities or assets described herein, and it is not intended to constitute tax advice but is provided solely for informational purposes. Investors should work with their advisors to understand these investments and their suitability in a particular portfolio management strategy, but some or all of these opportunities may certainly assist those in the highest tax brackets (which are going higher) and those having large portfolios of investable assets held outside of retirement accounts.

Recording Income Or Capital Gains

To keep a record of your investments income like interest share and also dividends or capital gains which are issued by mutual companies here are the procedures.

One you should display the investment account register, this is by clicking the accounts and bills link then select the account list then the money will show pick an account to use this window. After that click on investment accounts, then the display comes up for the account register for mutual funds. The second thing to do is to state that you want to record your purchase and additional shares from the mutual fund, after that click the investment transaction link, and then this information is added at the bottom of the account registry, and to record a new transaction click the new button.

The next thing to do is state on which day the income or capital gains were received in the date box. You can either enter the information in the box provided or you can click the date box button to access the program's pop up calendar. Next click the investment box and select the mutual funds from the list of investment funds shown. To identify this particular transaction you will have to enter it as capital gains transaction, click on the activity box and then select the preferred activity from the list. If you are particularly in record interest click on interest, if you are recording a dividend then select dividend. After that select the necessary option that you need.

Report It The Right Way On Your Federal Income Tax Return

It is important to understand capital gains and losses when filling out your federal income tax return. The category of capital asset includes almost everything you have which you use for personal and investment reasons. Your home, household furnishings, stocks, and bonds in personal accounts are considered capital assets. Your capital gains and losses are calculated from the difference between the amount you paid originally for that asset and the amount you received when you sold it.

The IRS publishes important information to help you understand how your investments affect your tax return.

When you are figuring out what is classified as a capital asset, remember that purchases you made for personal, investment, and pleasure purposes are all included. Upon your resale of that asset, you can calculate your capital gain or loss. The original purchase amount is generally your basis from which you will derive your loss or gain.

Make sure to report all of your investment income on your tax return on Schedule D, Capital Gains and Losses, and then transferred to line 13 of Form 1040. Keep in mind that you can only deduct capital losses that come from investment property, not from personal property. They are classified in accordance with how long you actually owned it. They are either short-term or long-term, and that classification is based on one year's time. If you held it for one year or less, it is considered short-term. If you held it any longer than one year, it is long-term.

To have net capital gain, your long-term gains must be greater than your long-term losses. The difference between your loss and you gain in this case equals your net capital gain. Net capital gain is calculated separately from your regular income because the tax rates are lower, typically 15 percent. For individuals with lower incomes, the tax rate may be as low as 0%, but some specific types of net capital gains are taxed at 25% or 28%.

On the flip side, if you lose more than you gain, you can deduct those losses on your income tax return. This could reduce up to $3,000 in taxable wages (or $1,500 if you are married filing separately). If your net capital loss is greater than this amount, then you can treat it on your next year's tax return as if it happened in that year.

More details on reporting these parts of your income are available on the Schedule D instructions, Publication 550, Investment Income and Expenses or on Publication 17, Your Federal Income Tax.

1031 Tax Deferred Exchange - 5 Steps to Success

There are as many reasons to seek a 1031 Tax Deferred Exchange as there are investors, but the fact is that completing such a property exchange can save you a significant amount of capital gains tax when you decide to sell your existing investment property and to acquire another one. Although you should always check with your tax advisor and attorney before you proceed, here are the basic steps to successfully exchanging a property under the 1031 guidelines.Step 1 - Proper Listing Once you've determined that a 1031 exchange is in your best interests, you'll want to list your current property with a real estate broker. Make certain that the listing agreement specifically specifies that you intend to use the property to complete a 1031 exchange.Step 2 - Sales ContractOnce a buyer has been found for your property, the next step is typical of a standard real estate transaction. You'll receive an offer, which you will then accept or counter. Once both parties agree to the terms and price, you'll have an acceptance and a sale, making sure that everyone is clear about the fact that you're intending to acquire a new property under the terms of Section 1031 of the IRS code.Step 3 - FacilitatorNext, you'll open an escrow account and begin working with a facilitator. The facilitator will prepare all the documents for a 1031 exchange and will work with the escrow company during Phase One of the process. The exchange agreement must be signed by everyone involved and all earnest money must be deposited with the title company before closing the escrow.Step 4 - Find Replacement PropertyYou must then find and identify the replacement property with 45 days of closing. You'll then have 180 days to acquire and close on that property, making sure that everyone concerned knows that it's part of a 1031 exchange.Step 5 - Close on Replacement InvestmentYou'll open an escrow account on the new property, and the facilitator will begin preparing all the documents required by Phase Two of the 1031 exchange process. Your earnest money and any other funds will be held in trust by the facilitator in the escrow account until the Phase Two transaction has closed.There are other factors that can come into play during the 1031 Exchange process, so it's important that you seek the help and advice of your financial advisor and attorney to make sure you're complying with the letter of the law from start to finish. There can be significant amounts of money involved, since you're allowed to exchange your current property for several new properties, as long as their fair market value doesn't exceed 200 percent of the value of your old property.Another thing to remember is that the properties must also be of a like-kind, meaning that they will both be held for productive use in a business or investment capacity. There are also some time constraints as to when you can claim the exchange on your income taxes, so as always, it's best to check with your various professional advisors before you begin the 1031 exchange process.Copyright © 2006 Jeanette J. Fisher

Capital Gains Tax (CGT) - UK Landlords

The other major tax that affects landlords only arises when they sell a property at a 'profit'. At this point you may be liable to pay Capital Gains Tax (CGT). The profit is obviously the difference between what you bought the property for and the selling price. The good news is that even if you have made a profit, you are still not automatically liable to pay CGT. This is because there are a number of exemptions and allowances.

Base Costs

First of all, before deducting your allowances you will need to establish the Base Cost of the property. To establish the Base Cost additional costs need to be added to the initial acquisition costs (or where the property was acquired prior to 31st March 1982 the market value on that date which ever is the higher - a process known as rebasing).
These are:

* Incidental costs of acquisition (e.g. legal fees, stamp duty, etc).

* Enhancement expenditure (e.g. the cost of building an extension to a property).

* Expenditure incurred in establishing, preserving or defending title to, or rights over, the asset (e.g. legal fees incurred as a result of a boundary dispute).

The initial capital gain is then calculated by taking the Base Cost from the sales price.

EXAMPLE
Tom bought his bungalow in July 1995 for £50,000. He paid stamp duty of £500, legal fees of £350, mortgage broker's fee of £250 and removal costs of £535.
The place was in a bad state of repair as an elderly couple had lived in it previously. Therefore, it needed complete modernisation. These works cost as follows:

1. redecoration £2000

2. new kitchen £5000

3. new bathroom £3000

Not content with this upgrading work for his tenants. Tom's next project was the erection of a shiny new conservatory to house his tenant's collection of carnivorous houseplants. This cost him an additional £15,000 (comprising of £14,000 construction cost and £1000 design and building regs fees).

However, in his enthusiasm to secure the maximum floor space. Tom built very close to his neighbours Jerry's boundary. Jerry was a little jealous of Tom's magnificent erection and aggrieved that it had crossed onto his boundary. He instructed his solicitor to send a letter threatening legal action to have it removed. Tom contested this and after Tom had spent £500 on legal fees, Jerry dropped his action.

In 1999 Tom suffered damage to his weather vein of £500. He secretly suspected that it was malicious damage by Jerry but was unable to proof anything. When Tom tried to claim for damage to his weather vein, the insurance company refused to pay out, stating it was storm damage and classed as an act of god not covered by his policy.

In 2000 fed up with Jerry's constant agitation. Tom sold his bungalow for £125,000. How much was Tom's Base Cost for CGT purposes?

ORIGINAL COST £50,000

Incidental cost of acquisition £1000 (legal fees, stamp duty and mortgage broker's fee). The removal costs were a personal cost and not part of the capital cost of the property.
Refurbishment works

£10,000 classed as enhancement works & therefore a capital cost
Building of conservatory

£15,000 also classed as enhancement works & therefore a capital cost
Legal fees defending title to property £500 contesting boundary with Jerry

TOTAL BASE COST

£76,500

Annual exemptions

The personal allowance allows each individual to make a certain amount in capital gains each year without having to pay CGT. These exemption changes every year. In the tax year 06-07 it was £8,800. Unfortunately, this exemption only applies in the year of disposal of the asset. Unused balances from previous years cannot be carried forward.

In addition to the annual CGT allowance there are a number of expenses and deductions that can also be taken into account to reduce your potential liability. Some of these are used to generate the Base Cost as previously mentioned. Expenses that are deductible are:

* the costs of acquisition such as solicitors fees, mortgage brokers fees, etc

* money spent on the property, including renovation and improvement costs

* the cost of disposal such as estate agents, solicitors, advertising. Remember not to get caught double counting the costs you may have already included under Schedule A as a repair.

It all seems fairly straight forward up to now!? However, just to make things a little more interesting, the Revenue have two minor complications called Indexation Allowance and Taper Relief.

Indexation

Indexation, which was effectively replaced by Taper Relief in 1998 was used by Government to account for inflation in the calculation of CGT. Therefore, where a capital gain was made, it allowed a proportion of the increase to be deducted.

This practice reflected the time when inflation alone would have resulted in large increases in capital value. It should also be noted that indexation relief may only reduce or extinguish a gain; it cannot convert a gain into a loss or increase a loss.

The calculation of the indexation allowance commonly called the 'indexation factor' is made according to the formula given below and rounded to three decimal places. The RPI or Retail Price Index is simply a measure of the price of goods and services produced by the Government's Office for National Statistics (ONS) as a way of measuring prices and inflation.

The formula for the Indexation Factor calculates what the rise in the value of the asset disposed of would have been as a result of inflation given the base date of March 1982 & the end date of April 1998 when Taper Relief was introduced. Often these figures have been already calculated and are available in the form of a table, which can be used to speed up the calculation process.

Formula for calculating the 'indexation factor'

RD = RPI in month of disposal or April 1998 whichever is the earliest

RI = RPI for March 1982 or month in which expenditure incurred, whichever is the Later

(RD - RI) / RI

Taper relief

From the 6th April 1998 taper relief took over from Indexation. Properties purchased before this date still benefited from indexation. However, gains after this date were subject to the new tax regime. Taper relief reduces the chargeable net gains according to how long the asset has been held.

Why is it called Taper Relief? This simply refers to the way that the amount of the gain liable for CGT 'tapers' off the longer the asset is held. Taper relief is given on the net gains chargeable after the deduction of indexation allowance and any capital losses realised. It is charged according to the rates stated in table A below.

Assets acquired before March 1998 qualify for an additional year to the period for which they are treated as held after 5th April 98. As you can see the taper for business assets is more generous. Unfortunately, residential rental property does not count as business asset because property investment is not classified as a qualifying trade. The exception to this is holiday lets. Investing in a holiday let therefore could be a way to acquire a property and dispose of it quickly without incurring a large CGT liability. I go on to discuss 2nd homes in more detail in the Landlords Bible.

TABLE A

No. of complete years after 5/4/98 for which asset held

Gains on business assets

% of gain chargeable Gains on non -business assets

% of gain chargeable

0 25 100

1 25 100

2 25 100

3 25 95

4 25 90

5 25 85

6 25 80

7 25 75

8 25 70

9 25 65

10 or more 25 60

It is possible to use the increased business taper relief where a qualifying business already exists and say acquires a residential unit for use by the staff. Such a unit is considered to be a business asset rather than a personal asset and therefore would benefit from the preferential taper relief. Obviously it would have to be made quite clear that the unit was used or required in connection with the business and was not just let to the public.

Occasionally the disposal of the investment property may not be through the open market but to a connected person e.g. to a relative or a family company. In this case HMRC makes the automatic assumption that the bargain is not at 'arms length'. In this case a "market value" is substituted for the actual sale proceeds if the two amounts differ.

Of course one thing to note is that valuation of property to many is an art not a science and as a result there is an acceptance that valuations by different agents can vary by as much as 10%. If you are planning a transfer, then make sure that you evidence your 'market value'.

Therefore, it would be best to obtain a number of written estate agents valuations. Obviously you then select the valuation that most closely reflects the 'market value' at which the transfer took place.

Generally, there is no CGT payable where there are transfers between husband and wife and also where property is transferred to a charity.

Main residence exemption

As I'm sure you are aware, where a property is occupied as a person's main residence they are not liable for CGT on disposal. This tax exemption is also known as Private Residence Relief or PRR. That's why you don't have to pay CGT when you sell your home. There are, as in all cases in tax law, complications. For instance when individuals are required to live away from their property in 'job related' accommodation. In these cases it is possible for them to nominate a property they own as their main residence, despite living elsewhere.

Examples of where this might occur are for a:

* pub landlord

* care worker

* agricultural worker

* vicar

Frequently the case arises where somebody buys a home and then has to move because of work, etc. In this situation they decide to rent out their house and therefore on disposal will not have lived in the property for their entire time of ownership. How does this affect their exemption status?

For a start, where a property was rented out prior to 31 March 1982, this period of non-qualifying use is ignored. The tax regulations allows for the proportion of the capital gain to be exempt where the conditions pertaining to primary residence are met. In other words the following equation applies where the period of qualifying use being that period where the property qualifies as the person's private residence or benefits from one of more of the stated exemptions.

Period of qualifying use/total period of ownership * (multiply) indexed gain

Finally, if you have lived at any stage in the property as your main residence, then the last three years of ownership qualify for exemption. This even applies when the period of occupation occurred prior to 31 March 1982.

The implications of this are that if you have a property with a large potential capital gain, derived during the last 3 years. Where you have not lived in the property before, you may want to consider moving into it as your main residence to reduce your tax liability.

Other exemptions of Private Residence Relief (PRR) that may apply are in circumstances where individuals are required to work away from home. If you think this may apply to you I would obtain a specialist tax text or consult a professional tax adviser as the matter can get very complex.

Alternatively try the practitioner's zone on the HMRC website. For further details on tax matters have a look at http://www.propertyhawk.co.uk for advice and the latest developments.

What is the rate of CGT?

This depends on what your income tax rate is. Any net gains are worked out after allowing for deductions and allowances. These are then added to your income tax liability. The rate charged corresponds to what would be payable if the sum was derived as income.

Some tax saving tips

I've listed below a number of tax savings tips that hopefully you will find useful. For more detailed advice on tax have a look at our tax professionals in the Recommended Links or go to the Landlords Bible.

You don't have to actually have completed a sale. The deal must have reached a point of no return. In technical terms, you must have an 'unconditional contract' for sale. This usually means that contracts have been exchanged and a completion date set.

Think about exploiting, the tax loophole, which allows you to remortgage your home and let it out using the funds to purchase a new home.

This little known loophole was brought about by technical changes in the 04-05 budget. For example, an owner-occupier bought a house for £150,000 using a £120,000 mortgage. The owner now wants to move but also to hold onto this property now worth 250k. Interest on the 120k and up to an additional 130k to enable him to withdraw his equity in the property can be all treated as an allowable expense for tax purposes and be offset against rental income.

Ensure that you claim or your allowances and expenses. Think creatively but realistically.

Capital Gains Tax deferment.

The Chancellor in his efforts to encourage investment in small businesses has created a mechanism to defer paying capital gains tax. Companies can now be set up under the umbrella Enterprise Initiative Scheme as qualifying investments. Investments in these companies allow investors to defer paying CGT and basic rate income tax.

How does it work? Let's start with the example where a property is sold realising a capital gain of £100,000 after allowances and deductions. The owner, as a top rate income tax payer would be liable to pay £40,000 CGT. However, they decide to invest the receipts of £100,000 into a EIS company. Following the approval of the investment by the Revenue the individual receives back the £40,000 back in tax. This means that for this £60,000 of funds the investor receives £100,000 worth of shares.

It gets better! It's also possible where you do not own the company to benefit from income tax relief at the basic rate of 20%. In this situation you would therefore receive £100,000 of shares for a £40,000 net investment. The bad news is that if you sell within 3 years the income tax relief is withdrawn & also you will not benefit from the exemption from capital gains in the share price made during that time.

Should you sell the shares at any stage the original CGT which was deferred is 'crystallised' and the tax will have to repaid. However, as long as you retain the investments or roll them over into another qualify investment the liability remains deferred. A word of warning through. Saving tax by putting money into a good investment can be an efficient way of investing money. However, putting your funds into a poor investment that goes bust will just means that you end up loosing your money as well as the 'taxman's'!

Allowable expenses

Often confusion arises over eligibility of items of expenditure allowable as an expense when calculating income tax liabilities. I have therefore listed below a number of these items under the headings; non allowable and allowable expenses:

Non allowable

1. fees in purchasing the property - included in the base cost when calculating any potential capital gain

2. expenses in connection with the first letting of a property for more than one year

3. repairs covered by insurance. Where a repair is covered then it is only the excess that should be claimed as an expense

4. replacement of a 'bog standard' kitchen with a 'top of the range' bespoke designer kitchen - classed as capital expenditure. See HMRC website's property income manual in the Practitioners Zone for detailed guidance and explanation on repair, reconstruction & improvement.

5. architect or building regulation application to alter property - classed as a capital cost

6. capital expenditure of providing the means of travel (normally a car) is not allowable as a deduction.

Allowable
1. costs of remortgaging a rental property such as surveyors, solicitors and mortgage brokers fees

2. fees received in evicting a tenant where a property is to be re-let

3. accountants fees!

4. cost of any services provided e.g. laundry, gardening and porter.

5. ground rents

6. any interest payable including personal loans and overdrafts which have been used to fund the investment

7. UPVC double glazed windows are now classed as a repair & therefore a revenue item even where they replace single glazing units.

8. costs of evictions e.g. legal costs, court costs, investigations

9. subscription to landlord organisations

10. 'revenue costs' of a car (the running costs e.g. fuel, road tax) of trips to rented property, it must be your primary purpose to visit the rental property. However, as the Revenue put it, if you stop off on the way to collect a paper this is ok! Where as if you set off to buy a paper and then visit a property on the way this is not. I think we all now how landlords would perceive this particular journey.

Reduce Capital Gains Tax in the Sale of a Business

Hopefully, before selling a business, you meet with a CPA or tax accountant and get an estimate on how much of your proceeds will be going directly to Uncle Sam if you pay them in a lump sum at time of sale. You don't want to save this surprise for after all is said and done, because not only will it most likely be a shock, but you will have given up your chance to do anything about it.

Planning is everything. For this article I will assume you are not doing a 1031 business exchange, that is selling your business and buying another similar business taking into consideration all the IRS guidelines and timelines. It's pretty rare to see this, but it can defer all of your capital gains tax if done correctly. A 1031 Exchange is more commonly implemented with real estate.

Depending on how the business is sold, the gains may be taxed as long term capital gain, short term capital gain, ordinary income, etc. and if you are selling an asset in a C-Corp you may face double taxation. So, the idea is to minimize your tax bill and maximize your proceeds no matter what situation you are in.

One option is with a Self Directed Installment Sale. The structure must be in place before the buy/sell agreement is signed. The gist is to receive the sale proceeds in installments and only pay capital gains tax as you receive the income. This has the effect of allowing the majority of money you would have paid immediately in taxes to continue earning compounded interest for you for many years, thus increasing your bottom line by a significant amount.

The details are a bit too complex to fully outline in a short article, but both an LLC and a Trust are created for you and set up meet IRS criteria for favorable taxation of installment sales. Your asset gets transferred to the LLC prior to sale, and your buyer purchases from your LLC. The trust buys the shares of your LLC from you via an installment agreement and you pay taxes on your gain only as you receive the payments.

You, the seller, are able to control when the payments begin and how long they will be spread out. This allows for maximum flexibility to control your income, and plan for future tax savings as well. Since your buyer paid cash in exchange for your property, you are not dependent on them to make the installment payments and you have transferred the risk of refinance or default. This is done by using an independent third party administrator and your money is safely invested in a principle protected insurance product to be used solely for the purpose of paying the installments.

If you pass on before receiving all of the payments due, the remainder of the installment payments pass to the beneficiaries of your choice.

Seeing an example of a taxed sale vs. a Self Directed Installment Sale side by side will show you how much of a difference in overall return this strategy will provide. This can make the process of the sale more palatable and provide a dependable income stream for retirement.

The tax benefit of this approach is similar to your 401K or IRA account. You reduce your current income by the amount of your annual contribution and thus defer the tax you would have paid on that income amount. Those funds are invested in stocks and bonds and grow in value, sometimes dramatically, for the period before you retire and start taking distributions. When you start distributions, the amount is treated as ordinary income and you are taxed at your much lower (you are no longer working and earning a big salary) income tax rate at the time.

The Self Directed Installment Sale allows you to similarly defer your capital gains tax from the sale of your business. Instead of paying all of your capital gains at time of sale, you set up your SDIS to pay out your sale proceeds over time. If you pay all of your capital gains tax at time of sale, that money is gone forever. However, with this vehicle, you spread your receipt of the sales proceeds out over, 15 years for example. When you receive your distribution, you are then taxed for the portion of that distribution that is attributed to the capital gains - generally about 15%.

The difference in after tax proceeds are dramatic and are demonstrated by a complex analysis called an illustration. I will try in an abbreviated fashion, however, to demonstrate the potential impact. If you sold your business and you had a capital gain of $3.46 million, your lump sum capital gains tax payment at a 15% rate would be $519,000. In the SDIS you would keep the entire sale proceeds of $3.46 million and take distributions over a 20 year period or whatever period you chose. You receive an annual payment over 20 years, that would consist of 1/20 of the principal, 1/20 of the capital gains, plus investment returns.

If we did an illustration of this case and compared selling the business and paying all the capital gains up front and invested the remaining proceeds in a 6.85% compound growth portfolio versus the SDIS paying 1/20 of the capital gains annually, you would gain an $831,000 advantage in after tax proceeds. Not to bad for a little advanced planning.

Investment Property Jargon Explained - Capital Gains Tax

The second in our series of articles about investment property jargon looks at capital gains tax.

If you successfully make money through buying and selling an investment property you'll want to hold on to as much of that profit as possible. So a thorough understanding of capital gains tax is essential.

The concept of capital gains tax is much the same in any country or market, it is a way for the local fiscal authorities to raise cash from the profit made by investors in real estate, as well as other asset groups.

The gain in capital you make on your investment property is essentially the difference between the price you paid and the price you sell it at. In other words: the profit.

Usually, capital gains tax is calculated as a simple percentage of this profit, but it may be possible to deduct other expenses from the gain, which will bring the amount down, and with it, the tax you pay.

In some areas the rate of inflation will be taken into account too, allowing you to calculate the "real" gain in capital relative to the economy as a whole.

As with most tax laws, people have always sought loopholes or ways to avoid paying it. In less scrupulous markets it's possible that the reported sale price of some investment property is lower than the true amount, thus reducing the investor's tax burden.

In countries where the sector is poorly regulated or policed, it's possible that a large part of the purchase price is paid "under the table" in cash, so the reported transaction price is lower than the real amount.

In its simplest form, the equation to calculate capital gains tax on investment property is:

(Sell Price - Buy Price - Deductible Expenses) x Capital Gain Tax Percentage Rate.

Since capital gains tax regimes can vary significantly between different countries and property markets, it is well worth seeking out an experienced adviser, such as an accountant, notary or lawyer, who can guide you through the different solutions.

If possible, find someone that is familiar with investment property in particular, since the rules for taxing real estate may be different to those for other types of assets with gains in capital.

The money they save you could pay for their services many times over in some cases, so it is well worth seeking their advice. For example, they may have tips on how to structure your deal so you can maximize the deductible expenses that you can subtract, or find a way of charging a lower tax rate on your capital gain.

Either way it's very simple: the more you can save on capital gains tax the more you can make on the sale of your investment property.

How Does 1031 Work?

If you are one of those who plan to sell your property, and utilize the proceeds of the sale for some other purposes, there is a tax liability that you are bound to incur. This is called the Capital gains tax. This is a method to ensure that anybody who sells of their property shall re-invest the amount back into real estate sector. Section 1031 of internal revenue is a law which works on these principles.

Section 1031 of internal revenue states that if an asset is sold and the ngains generated are used to buy another like wise asset, no gains are recognized, thereby implying that no tax shall have to be paid.

Section 1031 is a three step process which has to be completed within one hundred and eighty days. It is popularly known as 1031 exchange.

Step one involves sale of the property. The funds generated out of the sale are transferred to an authorized intermediary who shall hold these funds. A qualified intermediary is one who is authorized by IRS to hold these funds and facilitate 1031 exchange. This is to ensure that the seller does not utilize these funds for any other process.

Step two, which involves identification of property for purchase, has top be completed within forty five days of sale of first property. It is always advisable to shortlist atleast two to three properties of your choice, so that even if your initial choice does not materialize, you still have options to fall back on and you do end up paying the gains tax.

Step three is the most important and one where you have to proceed with caution, so as not to lose out on the opportunity. This is where you need to do the actual purchase of the replacement property, and the entire process has to be completed within 180 days of the sale of the first property. The intermediary shall pay out the closing costs and you will receive the title deed. Remember that the value of the replacement property should be equal to or higher than the value of the property sold initially. Only then can you defer your gains taxes. In case you have opted to buy a property with multiple owners, then it is prudent that you take the advice of tenant-in-common experts before finalizing the deal.

1031 exchange professional are available in the real estate market to help you work out good replacement deals and defer taxes. These professionals are knowledgeable about various aspects of the IRS code and can offer customized solutions.

With so much of cash being utilized in the real estate market, it is a good idea to defer taxes, as this amount can further be used to fuel the ever growing demand for real estate.