Building a Tax-Aware Keep-vs-Sell Model That Includes Recapture and 1031 Options

The row that is missing is 'equity available to reinvest', and it is 16% of the closing wire in this example

A typical keep-or-sell sheet ends at sale price minus loan minus commissions and calls that number your equity. It is not; it is the wire amount, and part of it belongs to the IRS and your state.

Using the hypothetical from how the four layers are computed — a $650,000 sale, $39,000 of costs, $220,000 adjusted basis, $80,000 of depreciation — the wire is $611,000 and the tax is $96,454. The sell column therefore reinvests $514,546, not $611,000.

Everything downstream inherits that error. A 6% assumed yield on $611,000 shows $36,660 of income; on the real $514,546 it shows $30,873, a gap of $5,787 a year that compounds through the whole projection.

Eleven inputs drive every output; collect them before you open the spreadsheet

Each of these is a number somebody already has — your closing statement, your depreciation schedule, last year's Form 8582. Guessing at any of them defeats the exercise.

Keep them on their own tab so you can change one and rerun all three columns.

• Original cost, land allocation, and every capital improvement with its in-service date.
• Accumulated depreciation from the current depreciation schedule, plus any years you were entitled to and did not claim.
• Current market value, realistic selling costs as a percentage, and the loan payoff with any prepayment penalty.
• Suspended passive losses from Form 8582 and any capital loss carryforward.
• Other taxable income and modified AGI for the sale year, and your filing status.
• Your state's rate on the gain and whether it conforms to §1031.
• Whether a cost segregation study ever reclassified components as §1245 property.
• Forward assumptions you own: rent growth, expense growth, capital expenditure reserve, exit cap rate and holding horizon.

Five formulas make the tax module, and they belong in cells rather than in a rate assumption

Resist a single "tax rate" cell. The layers are computed in sequence and the rate on each depends on the layer below, so hard-coding 20% or 25% will be wrong in both directions.

Build them as five rows that reference your bracket table for the year of sale.

• Amount realized = contract price − selling costs. Adjusted basis = cost + improvements − depreciation allowed or allowable.
• Depreciation layer = min(depreciation claimed, gain), taxed at ordinary rates stacked on other income but capped at 25%.
• Capital gain layer = gain − depreciation layer, stacked above the first two rows and tested against the year's zero-rate and 15% ceilings, $98,900 and $613,700 jointly for 2026.
• Surtax = 3.8% × min(net investment income, MAGI − $250,000 joint or $200,000 single).
• State tax = state rate × gain, then subtract the federal benefit of suspended passive losses released by the sale.

The hold column needs depreciation years remaining, because a 2001 purchase has almost no shelter left

Residential rental property runs 27.5 years with a mid-month convention, so a building placed in service in 2001 stops producing deductions partway through 2028. Modelling ten more years of the same depreciation number overstates the hold case badly.

Split the remaining life explicitly: a $240,000 building depreciating at $8,727 a year shelters that much of the rent until the schedule ends, and nothing after. Then the same rent becomes fully taxable and the hold column's after-tax cash flow steps down.

Publication 527 also settles a common modelling question: yearly depreciation "include[s] any depreciation that you were allowed to claim, even if you didn't claim it," so unclaimed years reduce basis in the sell column whether or not they ever produced a deduction.

The exchange column starts at $611,000 of equity but inherits the old depreciation clock

A fully deferred exchange puts the whole wire to work — $611,000 instead of $514,546 — and that difference is the entire economic case for it. Model it as a third column, not as a footnote on the sell column.

The catch belongs in the same column. Under Reg. §1.168(i)-6, when the replacement property has the same recovery period and method, "the replacement MACRS property is depreciated over the remaining recovery period," so your carryover basis keeps its old clock and only the new money you add starts a fresh 27.5 or 39-year life.

Two more lines belong here: suspended passive losses stay frozen rather than being released, and the deferred layers travel into the replacement's basis under §1031(d), to be paid on a future cash sale or erased at a step-up under §1014.

Compare after-tax IRR on one horizon, and sanity-check with return on equity in year one

Pick a single horizon — ten years is usually enough — and give all three columns the same terminal event so the exit tax is treated identically. Then report three numbers per column.

After-tax IRR is the headline. Terminal after-tax equity answers 'how much will I actually have'. Year-one return on equity is the quick sanity check that catches transcription errors, and low return on equity rentals explains how to define the denominator.

Every yield you plug into the sell and exchange columns is your assumption, not a quoted figure. Distributions on DST interests are projections set by the sponsor's offering documents and are not guaranteed; run the columns again at a lower rate before you trust the ranking.

Rerun it on events, not on a calendar

A model rebuilt every January is a model nobody trusts. Rerun when an input actually moves, and confirm any tax conclusion with your CPA or attorney before you act on it.

These are the triggers worth watching.

• Your depreciation schedule ends, or a major capital item is placed in service.
• Your taxable income shifts a bracket — retirement, a business sale, a spouse stopping work.
• Value moves more than 10%, or the loan hits a rate reset or maturity date.
• The inflation-adjusted breakpoints change each year under the annual revenue procedure.
• A partner, heir or co-owner wants out; see when only one partner wants cash.
• You are within a year of a plausible step-up, which changes the terminal event for every column.