A 1031 exchange is a tax strategy that allows you to defer paying capital gains taxes when you sell an investment property, as long as you reinvest the proceeds into a new, like-kind property. This means you can sell one property and buy another similar one without immediately paying taxes on any gains from the sale.
These like-kind exchanges are covered under Section 1031 of the Internal Revenue Code (hence the name "1031 Exchanges") and apply to federal capital gains taxes. However, each state has their own tax code, and may have different rules for real estate tax withholdings, the ability to complete a tax-deferred sale, or the rules around like-kind exchanges. Below we'll dive deep into these state-level specifics.
The Combined Rate accounts for Federal, State, and Local tax rate on capital gains income, the 3.8 percent Surtax on capital gains and the marginal effect of Pease Limitations (which results in a tax rate increase of 1.18 percent). The Combined Rate does not account for Wisconsin's allowance of a 30% State exclusion of Federally taxable capital gains.
Bracket levels adjusted for inflation each year. Release dates for tax bracket inflation adjustments vary by state and may fall after the end of the applicable tax year. The standard deduction phases out by 12 percent at $15,660 for single filers and 19.778 percent at $22,600 for married filing jointly. The standard deduction phases out to zero at $106,160 for single filers, $124,279 for joint filers.
Many states recognize and follow the federal rules for a qualifying 1031 exchange. We recommending reviewing these resources for 1031 exchanges at the federal level - learn about the rules for an exchange, the key deadlines you must meet, and why you are required to work with a Qualified Intermediary like Deferred.com.
In Wisconsin, community property, also known as marital property, includes assets acquired by either spouse during the marriage. This property is subject to equal division upon divorce. However, property owned before marriage, gifts, and inheritances are considered individual property unless they are commingled with marital property.
In a 1031 exchange, the property must be held for investment or productive use in a trade or business. For married couples in Wisconsin, both spouses are typically considered to have an equal interest in marital property. Therefore, both spouses must consent to the exchange, and the replacement property should also be held as marital property to maintain the tax-deferred status.
Disregarded Entities
Under federal tax law, a disregarded entity, such as a single-member LLC, is treated as if it does not exist for tax purposes. In Wisconsin, if a married couple owns a disregarded entity as community property, they can choose to treat it as either a disregarded entity or a partnership for federal tax purposes. This flexibility can be beneficial in structuring a 1031 exchange, as it allows the couple to maintain the continuity of ownership required by the IRS.
Divorce Implications for 1031 Exchanges
In the event of a divorce, the division of marital property, including any property involved in a 1031 exchange, must be considered. If the property is exchanged during the marriage and later divided in a divorce, the tax implications can be complex. It's crucial to ensure that any division of property complies with IRS regulations to avoid triggering a taxable event. Additionally, if a property is exchanged as part of a divorce settlement, it may not qualify for tax deferral under Section 1031 unless specific conditions are met.
In summary, while Wisconsin's community property laws provide a framework for property ownership and division, they also introduce complexities in the context of 1031 exchanges. It's essential to carefully consider these factors and consult with a tax professional to ensure compliance with both state and federal regulations when performing a like-kind exchange.
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