The end of a year usually brings excitement about a new year as well as a review of our goals and an assessment of where we are. As 2013 approached, many postponed financial decisions while others rushed to initiate or complete real estate and stock transactions because taxpayers had no idea what would happen to the Bush tax cuts that were set to expire at the end of 2012. After the November election, it seemed likely taxes would increase but how much and for who was still a question. We did know for sure that the new 3.8% Medicare Tax, part of the health care reform bill, would kick in on January 1, 2013.

The Taxpayer Relief Act of 2012 diverted the "Fiscal Cliff" but what does it mean to taxpayers, especially those who utilize 1031 tax-deferred exchanges. Following is a brief overview of what will affect investors and business owners:

Income Tax

For individual taxpayers with more than $400,000 in taxable income and married couples with $450,000, the top marginal income tax rate will rise to 39.6% in 2013. This is up from 35% in 2012. For taxpayers earning less, the 2012 income tax rates become permanent.  

Capital Gains and Dividends

Long-term capital gain and dividend tax rates will increase to 20% for individual taxpayers with more than $400,000 in taxable income and married couples with $450,000. The rates will remain 15% for those in the 25%, 28%, 33% and 35% income tax brackets and those in the 10% and 15% income tax brackets will continue to have a zero rate. Fortunately, regardless of your tax bracket, 1031 exchanges allow you to defer the capital gains on the exchange of assets held for business use or investment. Capital gains on collectibles remain at 28%.

Estate and Gift Tax

The $5,000,000 exclusion on estate and gift tax remains intact. The estate and gift tax for anything above the $5,000,000 will increase from 35% to 40%.

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Let's take a look at an example and see how a 1031 tax-deferred exchange might benefit the seller:

ASSUMPTIONS 

• Single individual taxpayer owned property for many years
• Annual Salary of $125,000 and $50,000 of additional income (interest, dividends, rental income)
• Paid $250,000 for the property a number of years ago
• Made no capital improvements
• Depreciated down to $100,000
• Selling for $500,000 (Capital gains of $250,000)
• With $175,000 of income, falls into 20% capital gains tax rate
• Subject to 3.8% Medicare Tax
• Subject to highest income tax bracket of 39.6%
• Deprecation recapture of $150,000 @ 25%