0% cap gains tax on rental property sales

[Finance Dave]

Need some tax clarification/guidance. I'll ask my CPA too, but he charges $150 for a consult so I want to be prepared going in.

We have sold 4 rentals this year...about $591k revenue on the sales. Subtract for commissions and so on, maybe down to $555 or so.

It's my understanding that so long as we keep taxable income (MFJ) below about $83k, there would be a zero Cap gains tax on these sales, is that correct? Yes, I understand we'd still have to pay the 25% on depreciation recapture...but I'm wondering about the gain on sale portion.

Also, I assume that these gains or the depreciation recapture do NOT flow through to taxable income in any way, right? In other words, it should all be handled on form 4797 and not transfer over to flow through taxable income in any way?

If I'm seeing this right, then here's what I'm hoping to do:
We are both retired other than the rental income, which is modest now that we've sold most of our units. I'm estimating we'd have about $15k in rental income for 2021. No other income other than minor interest on investments (most of our savings is in tax deferred retirement accounts).

That means I could go ahead and do a Roth conversion to get some of the money out of our TIRAs and into the Roths with minimal taxes being paid (at most the 12% marginal bracket) and still not exit the 0% cap gains rate on the rental sales.

2021 income would be:
Rental income - $15k
Roth conversion - let's say $75k
AGI would then be $90k
Deduct standard deduction of $25k
Taxable income $65k...well below the $83k limit that would trigger 15% cap gains on rental sales.

based on my very rough calculations, here is how I think the cap gains would play out...
Sales of houses $591k less selling expenses of $35k...so net sales $556k.
Subtract adjusted basis (original purchase price + immediate improvements) of $315k. That takes me to $241k gains. Add in the depreciation taken to date of $70k, that takes me to $311k that would be subject to cap gains taxes. At 15% (the normal rate), that would be $47k in taxes...but if I can keep taxable income below $83k, that would nullify all those taxes? I'd still pay tax on depreciation recapture, so $70k x 25%, or about $17k.

Please no comments on 1031 or other such things...this is a done deal. But if I can do this, it would allow me to get more funds into the Roth at minimal tax levels. Obviously the above is a bit oversimplified, but just trying to get a general sense about the 0% cap gains question.

Seems like I'm missing something. Thoughts or clarifications? Thanks all for any contributions.

 

[captain3d]

If you have $300k profit from the sales you will have plenty of taxes to pay. How is your income going to be reduced to under $80k?

 

[The Cosmic Avenger]

I don't know about rentals specifically, but in stocks, net capital gains always count as income for determining your bracket, so I'm 99.9% sure the $311K counts as income (unless you do something like a 1031), making your rate 15%.

 

[CRLLS]

I don't know about rentals specifically, but in stocks, net capital gains always count as income for determining your bracket, so I'm 99.9% sure the $311K counts as income (unless you do something like a 1031), making your rate 15%.

I was just checking yesterday on the sister to capital gains, qualified dividends. Using a Turbo Tax estimator, I believe this is true. As I add dividends above a certain amount, tax obligation increases. This is my 1st year for doing this so I may be surprised when I actually file my taxes.

 

[Dash man]

I think you need to pay for that CPA consult. Capital gains are taxable income. If your ordinary income is less than the ~$83k, you won’t have to pay capital gains tax on the gain between your ordinary income and ~$83k. Anything above that you have to pay tax on.

 

[COcheesehead]

Don’t forget recapture tax.
https://www.investopedia.com/terms/d/depreciationrecapture.asp

 

[WithAPurpose]

Dave,
That just doesn't sound right. I mean, we all want to find a way to avoid taxes on our real estate profits. So I went through my 2018 taxes when I sold one of my rentals.

I found that the instructions on form 4797 line 7 (I applied the Individual instructions) direct that the gain be entered on Schedule D. My tax program entered it on line 11 of the Schedule D which specifically calls out "Gain from Form 4797."
I will give the caveat that these are 2018 forms to which I am referring, so the past 5 years of changes have to be accounted for. But tax free property sales would have been a BIG change.

I'm sorry to quash your dream. Maybe do a pro forma tax return that includes the gain to see how much of your profit fits into the 0% bracket. I'm guessing you'll have to think about foregoing the Roth conversion this year.


Hope this helps,
Laura

 

[Finance Dave]

Thanks everyone, I see a trend in the responses. So maybe I skip the Roth conversion this year and instead I can get $83k of the gain on sale to be tax-free at least. Pay 15% on the remainder...and of course pay 25% on the recapture.

Yes, I will have the CPA do a pro-forma. I would do a TIRA contribution to lower AGI more, but don't have much in the way of "earned" income...so that won't work.

 

[captain3d]

Certainly no conversions this year. Tax loss harvesting is your goal for now.

 

[cathy63]

Thanks everyone, I see a trend in the responses. So maybe I skip the Roth conversion this year and instead I can get $83k of the gain on sale to be tax-free at least. Pay 15% on the remainder...and of course pay 25% on the recapture.

Yes, I will have the CPA do a pro-forma. I would do a TIRA contribution to lower AGI more, but don't have much in the way of "earned" income...so that won't work.

It's not correct that you'll pay 25% on the recapture. Recaptured depreciation is treated as ordinary income with a tax rate cap of 25%. If your other ordinary income plus recapture minus your deductions is less than $329,850 (the top of the 24% bracket for MFJ filers), then none of your depreciation recapture is going to be taxed at 25%.

You are probably not going to get $83K of your cap gain to be tax free. Take all your other ordinary income plus the depreciation recapture. Subtract your deductions. Then subtract that number from $83,350. That's the amount of LTCG that falls in the 0% bracket for you. Even if you have no other income, if the depreciation recapture amount is greater than your deductions, that alone will eat into the 0% bracket for LTCGs.

 

[audreyh1]

No, once your total income crosses around $100K (taking into account standard deduction) you will owe 15% capital gains tax on the remaining capital gains. You will also owe additional Net Investment Income Tax (NIIT) of 3.8% above $250K and the higher capital gains rate of 20% above around $500K.

Good year to skip a Roth conversion.

 

[Finance Dave]

Obviously I have lots to learn on this…I’ll meet with CPA in November…I just had knee surgery and am recovering

Thanks again all

 

[Sunset]

It's not correct that you'll pay 25% on the recapture. Recaptured depreciation is treated as ordinary income with a tax rate cap of 25%. If your other ordinary income plus recapture minus your deductions is less than $329,850 (the top of the 24% bracket for MFJ filers), then none of your depreciation recapture is going to be taxed at 25%.

You are probably not going to get $83K of your cap gain to be tax free. Take all your other ordinary income plus the depreciation recapture. Subtract your deductions. Then subtract that number from $83,350. That's the amount of LTCG that falls in the 0% bracket for you. Even if you have no other income, if the depreciation recapture amount is greater than your deductions, that alone will eat into the 0% bracket for LTCGs.

No, once your total income crosses around $100K (taking into account standard deduction) you will owe 15% capital gains tax on the remaining capital gains. You will also owe additional Net Investment Income Tax (NIIT) of 3.8% above $250K and the higher capital gains rate of 20% above around $500K.

Good year to skip a Roth conversion.

Thanks for these nice explanations, I'm going to save them for a future rental sale.