Selling rental, what taxes to expect

[HolaDEA]

The thing that sucks about selling a rental property is the depreciation recapture. That means that you have to pay tax at ordinary income rates on the amount of depreciation you have taken on the property. I was not thrilled to learn about this, but as long as you invested the tax savings from the depreciation expense every year, you usually come out ahead. I made an Excel template to walk through an example which I'll share.

Edit: oh well, it won't let me attach the Excel template for some reason.

 

[workmyfingerstothebone]

I’m not seeing overreach at all.

Your investment has grown a lot (especially related to your normal income) , you don’t like paying taxes on your profits - which usually means the profits are not enough for you to rationalize the taxes.

So, you cash out - this part makes sense.

Am I missing something?

Other than what we all know - no one likes paying taxes.

Have no problem paying taxes on a profit , if it's fair. In no way do I see this gouging as fair.

Besides the obvious act of forcing landlords to carry the burden of "non payment of rent" during the pandemic, there are other little things.

One that clearly irked me was the passage of a bill that mandated all homes in California have to have carbon monoxide detectors .

Why is that a mandate, can't people decide for themselves this issue? That's a rhetorical question.

This bill clearly is written for the manufacturers and who writes those bills...a politician certainly getting a donation.

 

[HolaDEA]

OP, you probably are aware of this already, but I see you have "basis for depreciation 78K", make sure you also reduce your gain by the cost of land. The land isn't depreciable so it is basis that is in addition to the depreciable basis, which will reduce the taxable gain.

 

[ivinsfan]

OP if you remember come back after tax time and tell us how much you payed in taxes.

 

[stephenson]

This sounds like the OP did not understand how rentals are treated by the IRS. And, setting aside the Federal government actions during the COVID national emergency, this lack of understanding clearly has created part of the anger.

Btw, we installed carbon monoxide detectors in our rental houses when we purchased them. We also replaced all smoke detectors at that time. We maintain the properties well and want our clients to be happy.

Further, we renovated them … so we could get more rental income and be able to sell if we thought appropriate to the market.

But, our long term goal was to use the properties as trans generational asset transfer devices.

 

[cathy63]

cost for original loan ?? not sure how to get those numbers, can I guesstimate


costs of all improvements -- can I add in costs like a roof put on before I started renting, new AC unit put on 12 years ago?

If you don't have info on the original closing costs, then you could make an estimate, but if you got audited (very unlikely), the IRS could disallow it. Anyway, the allowed closing costs are usually only a few hundred dollars. In California residential purchases it's basically just the title insurance, escrow fee and recording fee. Your other closing costs, such as points on the mortgage and property tax were deducted on your taxes over the years. If something was taken as a deduction, it's not part of your basis.

And yes, your basis includes the cost of improvements for the entire time you owned the home. Generally anything that's a permanent addition that would be sold with the house counts: built-in appliances, wall-to-wall carpeting, wood floors, cement patio, new roof, AC, etc. Repairs and normal upkeep, such as painting or power washing don't count, but you can deduct those as business expenses if you did them during the time that you rented out the house. The other tricky thing is that an improvement that is later replaced no longer counts towards your basis. So if you bought new carpeting after you'd owned for 10 years and again after 25 years, only the second carpet is part of the basis.

 

[Joylush]

This sounds like the OP did not understand how rentals are treated by the IRS. And, setting aside the Federal government actions during the COVID national emergency, this lack of understanding clearly has created part of the anger.

Btw, we installed carbon monoxide detectors in our rental houses when we purchased them. We also replaced all smoke detectors at that time. We maintain the properties well and want our clients to be happy.

Further, we renovated them … so we could get more rental income and be able to sell if we thought appropriate to the market.

But, our long term goal was to use the properties as trans generational asset transfer devices.

If you are referring to the stepped up basis upon death, that is potentially going away.

I had 34 rental houses and was retired to the extent I could be. I am down to 18. There is no way I wanted to be in my 70s or 80s or 90s and have to be managing rental properties. So as people move, I’m selling. I’ve just had to limit my sales to no more than three a year because of the enormous tax hit.

 

[pb4uski]

We've had the house 32 years, so the appreciation isn't that compelling. Averages to about $9300/yr appreciation. In the first few years (2-4) that's almost 9.5% but in the majority of the years it's more like 3.1% to 3.73%.


That's all before adding in any costs for maintenance, taxes, insurance. So the total yield is a little lower.


Only rented 11 years and in no way did the depreciation make up for the gouging we'll take from the State and Government. I think it depreciated about 3500/year. If I guess we paid 20%fed taxes then that comes to 700/year. Do that for 11 years and I saved 7700.00 in fed taxes, even less in state (my guess is $2000 in state taxes).



So for the privilege of saving less than 10K in taxes over 11 years, the state and government are going to charge me 70K to 90K WTF!


Others have mentioned it and the problem is the sale is a one time event so all the taxes come due in that one year.
It would be nice to spread that out.... managing my taxes for the future.

I'm confused... you say that you owned the house for 32 years but only rented it for the past 11 years... what did you do with the house in the first 21 years that you owned it?

If you had sold the house at the time that you decided to rent it out after owning it 21 years, what would your taxes have been on the sale?

 

[stephenson]

Sure, it’s been discussed by President Biden, and has a few previous presidents, before.

There has already been a lot of special interest group posturing on the topic.

IMO it is unlikely, but certainly possible.

Guess would need to decide in that case to sell and pay taxes, or let the kids sell (or rent) and pay taxes - either group would net significant profit.

From a national perspective, tax income is way lower than it needs to be (deficit and debt have been growing for decades) - wars have not been paid for, etc. So, taxes will be going up in a variety of contexts.

 

[ivinsfan]

I'm confused... you say that you owned the house for 32 years but only rented it for the past 11 years... what did you do with the house in the first 21 years that you owned it?

If you had sold the house at the time that you decided to rent it out after owning it 21 years, what would your taxes have been on the sale?

That's the tricky part if they lived in the house and then sold it the taxes might well have been zero...

 

[Joylush]

Sure, it’s been discussed by President Biden, and has a few previous presidents, before.

There has already been a lot of special interest group posturing on the topic.

IMO it is unlikely, but certainly possible.

Guess would need to decide in that case to sell and pay taxes, or let the kids sell (or rent) and pay taxes - either group would net significant profit.

From a national perspective, tax income is way lower than it needs to be (deficit and debt have been growing for decades) - wars have not been paid for, etc. So, taxes will be going up in a variety of contexts.

The problem is too many people not being required to pay federal taxes at all. The higher income folks are picking up most of the tab. Not enough people paying their fair share or any share at all. Add all the wasteful and unfunded spending, and here we are.

 

[ivinsfan]

The problem is too many people not being required to pay federal taxes at all. The higher income folks are picking up most of the tab. Not enough people paying their fair share or any share at all. Add all the wasteful and unfunded spending, and here we are.

With all your rentals you must have known how the taxes on them worked..


It's not a surprise.



No one likes paying taxes...

 

[Joylush]

With all your rentals you must have known how the taxes on them worked..


It's not a surprise.



No one likes paying taxes...

Of course I do. Maybe not going in. The first one I sold I owned for 33 years. I wasn’t thinking of potential tax consequences 33 years ago.

I think the depreciation recapture is what throws people off. Especially when you have no choice about it. You can’t opt to “not” claim the depreciation. And when you are in a lower tax bracket while “depreciating” it and then in a higher one when you sell it, it seems more like a trap and cost you more than you benefitted from it.

So the whole “well you get a tax benefit because you get to claim depreciation” is a misnomer. Because it is more of a penalty than a benefit in reality.

It’s not so much a dislike of paying taxes. It’s more a dislike of paying such an exorbitant amount compared to others who pay little to nothing, who take no risks, and who don’t provide a valuable public service like affordable housing for others.

 

[pb4uski]

The problem is too many people not being required to pay federal taxes at all. The higher income folks are picking up most of the tab. Not enough people paying their fair share or any share at all. Add all the wasteful and unfunded spending, and here we are.

I dunno, I don't see taxes as being very unfair at all. Do we really expect a married couple that earns less an $25,100 to pay income taxes? (They already pay SS taxes).

Below is a table of federal income taxes in 2021 for a MFJ couple compared to a 19% flat tax that would raise the same amount of tax. Lower income would pay a lot more while upper income would get a minor break.

Income	Tax	After-tax Income	Tax Burden	Marginal Tax Rate		Flat Tax	After-tax Income	Change in tax	Additional Tax Burden
40,000	1,490	38,510	3.7%			7,633	32,367	6,143	15.4%
80,000	6,190	73,810	7.7%	11.8%		15,265	64,735	9,075	11.3%
120,000	12,375	107,625	10.3%	15.5%		22,898	97,102	10,523	8.8%
160,000	21,175	138,825	13.2%	22.0%		30,531	129,469	9,356	5.8%
200,000	30,018	169,982	15.0%	22.1%		38,163	161,837	8,145	4.1%
240,000	39,618	200,382	16.5%	24.0%		45,796	194,204	6,178	2.6%
280,000	49,418	230,582	17.6%	24.5%		53,429	226,571	4,011	1.4%
320,000	58,818	261,182	18.4%	23.5%		61,062	258,938	2,244	0.7%
360,000	68,822	291,178	19.1%	25.0%		68,694	291,306	-128	0.0%
400,000	81,622	318,378	20.4%	32.0%		76,327	323,673	-5,295	-1.3%
440,000	94,422	345,578	21.5%	32.0%		83,960	356,040	-10,462	-2.4%
480,000	108,304	371,697	22.6%	34.7%		91,592	388,408	-16,711	-3.5%
520,000	122,304	397,697	23.5%	35.0%		99,225	420,775	-23,079	-4.4%

 

[SheitlQueen]

Seriously? You think taking away a landlords legal protection under the law isn’t overreach? How would you feel being told you had to give your extra car away to someone who was free to use because the government felt they needed it more than you do for going on two years with no compensation while you were expected to make the car payment, pay the taxes, insurance and replace the tires, oil and perform all other required maintenance while they were free to use it- and in some cases you were also required to keep it filled with gas for their use?

You think there is a shortage of affordable rental homes now…we haven’t see anything yet. This is one of the most egregious examples of government overreach ever.

In my state/county we have state wide rent control. I can't do a no cause eviction even if covid goes away. If I want to sell the place I can only sell it to someone who will use it as their primary residence. I have to pay $4500 in moving expenses to the tenant. These are other examples of government over reach.

 

[pb4uski]

Was state wide rent control in place when you bought the property?

 

[ivinsfan]

You make some good points JoyLush, but you're not in a unique situation.

I have things I can vent about too.

Farmland owned over 30 years....try selling and seeing what the tax bill is...yes you could do installment sales but some people have a bad habit of defaulting on land contracts for deeds.

Now back in 2001 after my Mom died I put my share of money from selling her house into IBonds, that will mature in 2031 and 2032, the tax due on those will make the top of your head blow off.

So at some point if you have money, assets you'll pay the taxes and no one is happy about it but we don't have much control over it either. Best not to get too worked about it. No doubt 99% of people would consider me a whiner about the two examples listed above .

 

[Joylush]

I dunno, I don't see taxes as being very unfair at all. Do we really expect a married couple that earns less an $25,100 to pay income taxes? (They already pay SS taxes).

Below is a table of federal income taxes in 2021 for a MFJ couple compared to a 19% flat tax that would raise the same amount of tax. Lower income would pay a lot more while upper income would get a minor break.

Income	Tax	After-tax Income	Tax Burden	Marginal Tax Rate		Flat Tax	After-tax Income	Change in tax	Additional Tax Burden
40,000	1,490	38,510	3.7%			7,633	32,367	6,143	15.4%
80,000	6,190	73,810	7.7%	11.8%		15,265	64,735	9,075	11.3%
120,000	12,375	107,625	10.3%	15.5%		22,898	97,102	10,523	8.8%
160,000	21,175	138,825	13.2%	22.0%		30,531	129,469	9,356	5.8%
200,000	30,018	169,982	15.0%	22.1%		38,163	161,837	8,145	4.1%
240,000	39,618	200,382	16.5%	24.0%		45,796	194,204	6,178	2.6%
280,000	49,418	230,582	17.6%	24.5%		53,429	226,571	4,011	1.4%
320,000	58,818	261,182	18.4%	23.5%		61,062	258,938	2,244	0.7%
360,000	68,822	291,178	19.1%	25.0%		68,694	291,306	-128	0.0%
400,000	81,622	318,378	20.4%	32.0%		76,327	323,673	-5,295	-1.3%
440,000	94,422	345,578	21.5%	32.0%		83,960	356,040	-10,462	-2.4%
480,000	108,304	371,697	22.6%	34.7%		91,592	388,408	-16,711	-3.5%
520,000	122,304	397,697	23.5%	35.0%		99,225	420,775	-23,079	-4.4%

Yes, we disagree. Everyone should be required to pay something. And you’re leaving off the additional 3.8% Obamacare tax required on incomes over 200k as well as state taxes when it applies (and does in most states).

 

[Sunset]

.....

Now back in 2001 after my Mom died I put my share of money from selling her house into IBonds, that will mature in 2031 and 2032, the tax due on those will make the top of your head blow off.

... .

Not suggesting you want to do this, but I wonder if it's possible:

Are you able to start declaring the I bond interest each year ?

I know at the beginning one can declare it each year, or at the end, but is there a mechanism for starting to declare it each year when some years have gone by:
Perhaps one could claim (all previous years interest) then continue with yearly interest claims until the end ?

 

[Joylush]

You make some good points JoyLush, but you're not in a unique situation.

I have things I can vent about too.

Farmland owned over 30 years....try selling and seeing what the tax bill is...yes you could do installment sales but some people have a bad habit of defaulting on land contracts for deeds.

Now back in 2001 after my Mom died I put my share of money from selling her house into IBonds, that will mature in 2031 and 2032, the tax due on those will make the top of your head blow off.

So at some point if you have money, assets you'll pay the taxes and no one is happy about it but we don't have much control over it either. Best not to get too worked about it. No doubt 99% of people would consider me a whiner about the two examples listed above .

I don’t consider you a whiner. Then again I’m not sitting around bashing those who make more than I do and claiming they don’t pay their fair share. They pay more than their fair share. They pay their fair share as well as paying the fair shares of so many who pay little to nothing.

 

[ivinsfan]

I don’t consider you a whiner. Then again I’m not sitting around bashing those who make more than I do and claiming they don’t pay their fair share. They pay more than their fair share. They pay their fair share as well as paying the fair shares of so many who pay little to nothing.

Well my point was there really is nothing we can about it so it's more calming mentally and stress wise to try not dwelling on it.

But with what you wrote about selling off your rentals in the last few years I can see why it's a very sensitive topic to you...I completely get that.

 

[ivinsfan]

Not suggesting you want to do this, but I wonder if it's possible:

Are you able to start declaring the I bond interest each year ?

I know at the beginning one can declare it each year, or at the end, but is there a mechanism for starting to declare it each year when some years have gone by:
Perhaps one could claim (all previous years interest) then continue with yearly interest claims until the end ?

I don't know and I don't trust the IRS to keep things straight. Looking back it would have been best to do that from the beginning.

Who would have thought that interest rates would go low and stay low for decades? Who would have thought that the inflation adjustment would turn into such a big bonus. I always thought I would sell off a few at a time and had no idea I would want to keep them all for 30 years..I'll just have to start looking at our tax situation starting in the late 20's and figure the best way to go taxwise.

 

[Joylush]

Well my point was there really is nothing we can about it so it's more calming mentally and stress wise to try not dwelling on it.

But with what you wrote about selling off your rentals in the last few years I can see why it's a very sensitive topic to you...I completely get that.

I’m sorry if I came off as over stressing about it. It is what it is and based on what I know from being a landlord for 35 years it’s not something I would encourage my kids to get in to.

In my case I’ve found that I need to sell three houses per year and the profit on the third house covers the taxes due on the three of them. I make myself feel better by remembering the $6000 new AC (one example) is only really costing me around $4000.

And my goal now is to be sure to spend as much as possible to avoid estate taxes. I can look at that as whatever I want to buy I’m getting for 40% off. Can’t wait to get my Altoz tracked zero turn mower. It will compliment our new John Deere tractor well. Of course I’d rather leave the money to my family but that’s not possible without losing 40% to taxes.

Tax policy does drive behavior. I would be married but it would hit my other half too hard tax-wise being married to me. He’d like to sell his rental property but that would cost him over 10k in health insurance subsidies.

The idea of the government taking 40% of what you’ve worked your lifetime to earn is bothersome for sure. Especially the way they’ve devalued the dollar.

 

[pb4uski]

Yes, we disagree. Everyone should be required to pay something. And you’re leaving off the additional 3.8% Obamacare tax required on incomes over 200k as well as state taxes when it applies (and does in most states).

I'm not aware of any tax system where the first dollar of income is taxed, and you would have to do that if everyone paid something... so I don't see that happening and it has never existed in your lifetime so it isn't a realistic expectation.

Actually, the amounts in the table were arguably overstated because I ran the comparisons with all ordinary income and in reality, a large proportion of those with high incomes are taxed at more favorable preferential rates. If I go back and say that the $520k is all preferenced income then the tax, including NIIT is $72,375 or only 13.9%.

 

[RetiredAndLovingIt]

My son did a 1031 exchange when he sold his first rental last year in California and found out what his tax burden would be. He sold the house and bought a cabin in Big Bear for close to the same amount of money which he lists on Airbnb and made a lot of money last year far more than he expected, he only did it to give himself some breathing room to figure out the tax situation. After he has owned it for a year he can legally change his address to that location, drivers license etc and get a homeowners exemption on that property. The law allows for a husband and wife to own two properties. He has not done that yet and not sure he will. At some point he will have to pay the piper but maybe when his income is lower. In the winter he was getting $400 a night on holiday weekends for a tiny cabin and when it's not rented they can go there for vacations, it's less than an hour away. They control when and how much it lists for, the lowest being about $150 a night. There are a lot of expenses involved, it has to be professionally cleaned after every visitor, a local lady cleans it, washes the towels and linens and restocks for about $80 after every guest leaves. On Christmas Day he was called out because the guests could not figure out how to turn on the heating and that was a bit of a pain. There are some city taxes but overall he says far less hassle and work than with his renters and no government renter rules to worry about. I think he made about $15,000 in less than 6 months last year and that was when they had no clue what they were doing, they were just trying to clear enough to cover the small mortgage they took on it. Just something to consider but you only have 45 days to identify a new property for 1031 exchange AND Joe Biden wants to get rid of what he considers a tax dodge. Definitely talk to tax professional if it's a consideration. He's not making so much now because no snow in the summer but that's fine with him, and he can control his income by simply not renting it.
He sold his second rental this year but had lived in it for two of the last 5 years so they were able to avoid capital gains on a good portion of the sale. He now lives in a nice house on the lake that he bought last year that cost him less than what he sold these two rentals for due to the insane selling prices right now.