Understanding 2013 capital gain tax rates

Under the American Taxpayer Relief Act of 2012, the top capital gain tax rate has been permanently increased to 20% (up from 15%) for single filers with incomes above $400,000 and married couples filing jointly with incomes exceeding $450,000. In addition, the new IRC Section 1411 3.8% Medicare surtax on net investment income, which includes capital gains, results in an overall rate for higher-income taxpayers of 23.8% - a staggering 58% increase from 2012 tax rates! Five Steps Involved in Determining Capital Gain Taxation Absent the tax deferral benefits of a 1031 exchange, below is a summary of the five ways investors will be taxed on the sale of an investment property: Depreciation Recapture: Taxpayers will be taxed at a rate of 25% on all depreciation recapture. Federal Capital Gain Taxes: Investors owe federal capital gain taxes on the remaining economic gain depending upon their taxable income. Since a new higher capital gain tax rate of 20% has been added to the tax code, investors exceeding the $400,000 taxable income threshold for single filers and married couples filing jointly with over $450,000 in taxable income will be subject to the new higher tax rate. The previous federal capital gain tax rate of 15% remains for investors below these threshold income amounts. New Medicare Surtax Pursuant to IRC Section 1411: The Health Care and Education Reconciliation Act of 2010 added a new 3.8% Medicare Surtax on "net investment income." This 3.8% Medicare surtax applies to taxpayers with "net investment income" who exceed threshold income amounts of $200,000 for single filers and $250,000 for married couples filing jointly. Pursuant to IRC Section 1411, "net investment income" includes interest, dividends, capital gains, retirement income and income from partnerships (as well as other forms of "unearned income.") State Taxes: Taxpayers must also take into account the applicable state tax, if any, to determine their total tax owed. In the Northeast, that rate generally ranges from 6-8%. Local Taxes: Any taxpayers residing in NYC or one of its boroughs or selling property located there will incur a local capital gain tax of 3.8%. Other localities may have similar local taxes which apply. Despite these new tax increases, one aspect of the tax code provides real estate investors with a huge tax advantage. Section 1031 allows property owners holding property for investment purposes to defer taxes that would otherwise be recognized upon the sale of investment property. Savvy investors use 1031 exchanges to redeploy their investment capital into better performing investment properties. An exchange provides a fantastic opportunity for investment property owners to defer all capital gain taxes that would otherwise be owed. Pamela Michaels is an attorney and vice president and Scott Saunders is a senior vice president at Asset Preservation, Inc., New York, N.Y.