When Are Taxes Due In This Scenario?

Comments(4)

• 
  DaveREI22nd September, 2003

  You need to find a CPA who is Real Estate Literate...
  
  It also helps to professionally organize your biz.....INC, LLC, etc....[ Edited by DaveT on Date 09/22/2003 ]

• 
  DaveT22nd September, 2003

  Your tax liability on the sale of your investment rental property has two components -- depreciation recapture and capital gains.
  
  Your taxable profits are calculated by subtracting your cost basis from your net sale proceeds. Let's say that in your scenario, you sell for the amount of the remaining mortgage (about $92000) and do not have any selling expenses. Your profit from appreciation is $32K ($92K minus $60K). Let's say you use the maximum capital gains tax rate -- 15%.
  
  Along the way you also took three years of depreciation expense totalling about $6600. Depreciation is recaptured at 25%.
  
  Now let's figure out your tax liability. First, the depreciation recapture will be $1650 ($6600 x 25%). The first $1650 of your sale proceeds will be used to pay your depreciation recapture tax. Next, the tax on your profit from appreciation will be $4800 ($32K x 15%).
  
  Adding these two together gives you a tax bill of $6450 on the sale of your investment property.
  
  The money you received from your refinance is tax free. Borrowed money is not taxable income because it must be repaid. However, in your example you sold for the amount of your remaining mortgage balance and, therefore, did not receive any cash from the sale at the settlement table. Instead, you got your "profit" earlier when you cashed out some of the equity in your property. I hope you will still have at least $6450 set aside from your refi proceeds to pay the tax bill.

• 
  RaDoonZ22nd September, 2003

  Thanks for the quick replies!
  
  What would improve the "scenerio"? Of coarse, if I sold the house for a $10K over what is owed, that would be enough to cover the Capital Gains from the earlier REFI and the additional $10K.
  
  But, maybe there's a better scenerio. Please, feel free to optimize the plan...
  
  Steve
  .

• 
  DaveT22nd September, 2003

  Let's say that in three years, your $125K property further increases in value to $145K (a modest 5% annual increase).
  
  Let's say you sell the property for $140K rather than the remaining mortgage balance of $92K. After selling expenses and sales commission, let's say your net sale proceeds are $130K.
  
  Now, the previous scenario did not put any extra money in your pocket to pay the federal income tax bill. It was unsaid earlier, but we all understand that you may still have state income taxes to deal with in addition to the federal tax bite -- still with no extra money in your pocket from the sale proceeds.
  
  But, if you sell the property for FMV, you will have an extra $38K in profits. After you pay the federal income taxes, you will have $25850 left in your pocket. Should be enough to address your state tax liability if applicable.
  
  Does this improve the scenario to your liking? If not, don't sell the property. Instead, consider participating in a tax-deferred exchange to defer the capital gains tax bill until the replacement property is sold (if ever).