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Take the money and pay the tax
Dear Tax Talk:
I bought a 40-acre parcel in March 2002
for $30,000. I am now selling it, four months later, for $65,000.
What kind of capital gains tax will I pay? What are
my options for a 1031 exchange? Can I buy another piece of less
acreage, 10 to 20 acres, in another city? Do I have to use the whole
$65,000 or just the profit of $35,000?
At some time in the future, could I build a home on
the new property and live there? Since the sale is still pending,
would it be in my best interest to hold out for one full year of
ownership? Would I pay a lot less in capital gains tax?
Jon
Dear Jon:
The proverbial 40 acres and a mule seem to have outpaced
the heydays of the tech-bent NASDAQ. Since you owned the property
for less than a year, you need to realize that you'll be paying
capital gains tax at short-term rates. This is the same rate that
applies to your ordinary income.
Assuming you don't have capital losses, which is likely
given your Midas touch, you'll be paying tax on the $35,000 gain
based on the 2002
tax tables depending on your filing status and other income.
If you want to get into a like-kind
exchange, also known as a 1031 exchange because of the tax code
section in which it is addressed, you need to arrange for it before
you close on the sale of the property. Most title companies and
attorneys can help you accomplish a like-kind exchange.
You can reduce the acreage and change cities, but
you have to reinvest the full amount that you realize in order to
avoid paying capital gains tax on the profit. If you take back cash,
which is termed boot, you'll recognize gain to the extent of your
gain or the boot, whichever is less.
You can't go into the exchange contemplating building
a personal residence on the property in the future. However, if
five years from now you do build that home it won't change the tax
consequences in 2002.
In my opinion, if you have the opportunity to
sell at such a great price in such a short time frame, go for it,
as you never know what the future holds. If you need cash out of
the replacement property, you can later obtain a mortgage and cash-out.
-- Posted: July 25, 2002
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