Tax implications in selling rental property?

[Mykle57]

Wondering about tax implications in selling rental property. Thought I'd ask the smart people here.

My DGF is selling a multifamily property she has owned for 33 years. Was originally owner occupied, but, 20+ years ago she moved in with me and it's been rented ever since.
My understanding is that she will owe tax on the entire gain, this tax year. She's likely depreciated the property over time, so nearly the entire sale price (less expenses) will be taxable this year. Since it is not her primary residence, she won't be able to use the 1 time exemption. Set me straight folks.

Yes, I suggested she talk with her 'advisor' at Merrill (whos opinion she respects far more than mine) before she starts thinking about what she's going to be able to buy. (btw, it sold in 4 hours with multiple over list price offers).

 

[38Chevy454]

Yes on paying full price on the capital gains and depreciation recapture. Being owned for so many years, I am sure that the basis is very low vs sale price.
I'm not a tax expert, but she should look into a 1031 exchange.

 

[RetireeRobert]

Yes on paying full price on the capital gains and depreciation recapture. Being owned for so many years, I am sure that the basis is very low vs sale price.
I'm not a tax expert, but she should look into a 1031 exchange.

Since you mention the property has already been sold, it may be too late for these options to be implemented, but just in case:

The 1031 exchange option would be good if she wants to have her money in another real estate investment property. It would defer the tax hit. It will require identifying and contracting for purchase of the replacement property within I believe 45 days.

Another possibility would be to sell the property on contract and have payments come in over multiple tax years. For example, she could take 25% down this tax year, and get monthly payments over some time span, say five years, or ten years, or fifteen years. Or she could ask for 25% each year for four years (plus interest). Or whatever combination of getting/delaying some of the sales price works best to optimize her tax hit.

 

[Peter]

Can be a big tax hit. 25% on the depreciation component, 15% LTCG, maybe 20% if income is high enough. And then there's NIIT. And state taxes.

1031 exchange is OK if you want to remain a landlord.

 

[Joylush]

Yes, she will owe the depreciation recapture rate on the amount depreciated and long term capital gains tax rate on the difference between the purchase price and selling price (adjusted by any capital improvements not fully depreciated and minus the selling costs).

I have been selling three per year and it is a big tax bite because depending on your income there is also the extra 3.8% Obamacare tax on investment income.

If you want out of the rental business there really isn’t any way to avoid it. At least the long term capital gains rate is still reasonable.

And even if she never claimed any depreciation they don’t care. You still pay the tax on the amount you should have been claiming whether you actually did or not.

 

[Scuba]

We own a rental property that we have not been able to deduct rental losses on most years as our income was too high. Therefore we have accumulated capital losses that are likely to exceed the capital gain when we sell. Will we still have to pay the 25% tax on depreciation recapture even though we won’t have a net capital gain?

 

[euro]

We own a rental property that we have not been able to deduct rental losses on most years as our income was too high. Therefore we have accumulated capital losses that are likely to exceed the capital gain when we sell. Will we still have to pay the 25% tax on depreciation recapture even though we won’t have a net capital gain?

Yes

 

[euro]

Since you mention the property has already been sold, it may be too late for these options to be implemented, but just in case:

The 1031 exchange option would be good if she wants to have her money in another real estate investment property. It would defer the tax hit. It will require identifying and contracting for purchase of the replacement property within I believe 45 days.

Another possibility would be to sell the property on contract and have payments come in over multiple tax years. For example, she could take 25% down this tax year, and get monthly payments over some time span, say five years, or ten years, or fifteen years. Or she could ask for 25% each year for four years (plus interest). Or whatever combination of getting/delaying some of the sales price works best to optimize her tax hit.

Agreed - those are your only options, other than donating the property to charity. Owner financing can be advantageous for both seller and buyer and often you can get a higher price or a really attractive interest rate. However, make sure you minimize default risk by requiring insurance/property tax escrow and a significant down payment (large enough to cover a foreclosure process, if one becomes necessary). Run credit and background checks on the buyer. When set up properly, this can spread your tax burden and provide a steady flow of income.

 

[Mykle57]

Thanks folks,
It's what I thought, she's going realize a healthy tax bill next April.
Don't believe she's planning to reinvest in another (like-kind) property any time soon.

Will this tax be due April 15th, 2022, or will she need to make quarterly tax payments ahead of time?

 

[euro]

Thanks folks,
It's what I thought, she's going realize a healthy tax bill next April.
Don't believe she's planning to reinvest in another (like-kind) property any time soon.

Will this tax be due April 15th, 2022, or will she need to make quarterly tax payments ahead of time?

This tax is due when the sale closes, so she will have to make a tax payment around that time in order to avoid being hit by penalties. Unless he "normal" waxbill is huge, this sale will far exceed any safe harbor provisions.

 

[cathy63]

We own a rental property that we have not been able to deduct rental losses on most years as our income was too high. Therefore we have accumulated capital losses that are likely to exceed the capital gain when we sell. Will we still have to pay the 25% tax on depreciation recapture even though we won’t have a net capital gain?

Depreciation recapture is taxed at the same rate as ordinary income, except it's capped at 25%; so you will only pay 25% on the portion that pushes your income above the top of the 24% bracket ($329,850 for MFJ in 2021). If you have a capital loss or a capital loss carryover, then that offsets the depreciation recapture.

If you have a passive activity loss carryover, which is probably what you have from your rental property, then that offsets the capital gain on the sale of the rental property.

 

[Scuba]

Depreciation recapture is taxed at the same rate as ordinary income, except it's capped at 25%; so you will only pay 25% on the portion that pushes your income above the top of the 24% bracket ($329,850 for MFJ in 2021). If you have a capital loss or a capital loss carryover, then that offsets the depreciation recapture.



If you have a passive activity loss carryover, which is probably what you have from your rental property, then that offsets the capital gain on the sale of the rental property.

Thank you. So to use an example, if we sold the property at breakeven, had taken depreciation of $200K, but had $200K of passive activity loss carryovers, our net tax liability related to the sale would be zero?

If instead we sold the property for a $300K gain, we could offset the $200K passive activity loss, so our capital gain would be $100K but we would also have to pay up to 25% tax on the depreciation recapture depending on our ordinary income bracket?

I appreciate your help!

 

[Scrapr]

Look out for AMT as well. I have only paid Alternative Minimum Tax once...in the year I sold a rental. I don't understand how AMT works or the in's & outs. But that was my one off experience

 

[Winemaker]

Thank you. So to use an example, if we sold the property at breakeven, had taken depreciation of $200K, but had $200K of passive activity loss carryovers, our net tax liability related to the sale would be zero?

If instead we sold the property for a $300K gain, we could offset the $200K passive activity loss, so our capital gain would be $100K but we would also have to pay up to 25% tax on the depreciation recapture depending on our ordinary income bracket?

I appreciate your help!

Yes, to a point. If your passive activity loss is made up of a greater percentage due to depreciation, this may not be a perfect wash. Depreciation, as you know, is a non cash expense taken annually, that reduces your basis. If your annual loss is due to a large depreciation expense, the taxman will still cometh.

 

[cathy63]

Thank you. So to use an example, if we sold the property at breakeven, had taken depreciation of $200K, but had $200K of passive activity loss carryovers, our net tax liability related to the sale would be zero?

If instead we sold the property for a $300K gain, we could offset the $200K passive activity loss, so our capital gain would be $100K but we would also have to pay up to 25% tax on the depreciation recapture depending on our ordinary income bracket?

I appreciate your help!

This is a complicated question, so you really should use some tax software to see what happens in your specific case.

I think you would still have to report the depreciation recapture as "Unrecaptured Section 1250 Gain" on Schedule D. You can offset it there with capital losses, not passive activity losses. The Schedule D Tax worksheet is where the actual tax is calculated for all the different types of gains.

The passive activity losses would be used on Sched E and form 8252. Just looking at those forms, I think you could wipe out the regular long term cap gains (i.e. end up with $0 net gain or even a loss on the sale) but the section 1250 gain reporting seems to be a separate thing.

I am really not sure of this though, so please do your own testing. I've been playing with some numbers for the property we want to sell, so I know how depreciation recap works for us, but we have a net profit and only a very small passive activity loss carryover, so I haven't worked through a case where depreciation recapture is greater than the profit on the sale.

Here's the investopedia page on depreciation recapture in case it helps: https://www.investopedia.com/terms/u/unrecaptured-1250-gain.asp