I am considering selling a rental property I have owned since 1998. The property is a duplex which my wife and I lived in one half for a little over two years just after we bought it. I have a few questions on my exposure to capital gains taxes.
Does the fact that I lived there have any effect on what I might have to pay in capitol gains?
How is the ammount of capitol gains calculated? Is is the difference between what I paid and sold it for? Or is is the the different between the depriciated value and what it is sold for?
If I roll the money into another property or into my personal home will that have any effect on my tax exposure?
Besides not selling are there any other ways to avoid paying cap gains?
My understanding of RE tax law used to be very good, but it is now dated. Verify everything I tell you below.
The fact that you used to live there is old news now. You own investment property.
Any tax is payable on the difference between your receipt from the sale and your basis in the property. To the extent you have taken depreciation, your basis in the property has been reduced by the amount of your depreciation.
We are talking long term gains here, taxed at only 15%, so don’t be a pig. Pay the tax is almost certainly your best plan.
As the above poster said, a 1031 sale would avoid any tax, but for this size property is probably not worth the cost of the paperwork. Pay the tax.
If you lived in the property as your principal residence for 2 of the last 5 years, you may be able to exclude up to $500,000 of the gain. It sounds like you lived there outside of the 5 year window, so that’s probably out. You could move into the duplex and live there for 2 years, thereby converting it to your principal residence. At that point, you would be eligible for the $500,000 exclusion and only pay tax on the depreciation you deducted while it was a rental.
Capital gains tax would otherwise be due on the net selling price versus the adjusted basis (cost plus improvements less depreciation).
Your main option for delaying the tax is to do a Sec. 1031 exchange into another investment property of equal or greater value. Some people have been doing a Sec. 1031 exchange into an investment property, renting it out for a couple of years, then converting that into their personal residence. If you do convert a property you acquired in a Sec. 1031 exchange, however, you can’t get the $500,000 exclusion until 5 years after the Sec. 1031 exchange.
If you have an investment property in mind to replace it, the Sec. 1031 exchange is really not that difficult or expensive. The hard part most people have is finding a good replacement property that you can make money off as a rental with current prices.
You may be able to sell the rental on an installment sale, where you carry some or all of the paper, and you can recognize the gain over the period you collect the principal. This can spread out the tax bite some, but you are now in the position of being a lender, which some people would prefer not to be in.
**We are talking long term gains here, taxed at only 15%, so don’t be a pig. Pay the tax is almost certainly your best plan. **
Close, but not completely accurate. If he’s been taking depreciation deductions, the depreciation “recapture” is taxed as ordinary income. Any amount over the original purchase price would be capital gain, and subject to the 15% federal rate.
You may also have to deal with unrecaptured 1250 gains, which would be subject to a maximum 25% rate.
An example:
Taxpayer sells property for $1MM. He purchased property more than one year ago for $700K, and has taken $300K in depreciation expense. Of the $300K in depreciation, $100K was using accelerated methods (anything faster than straight line depreciation like 150 or 200DB). His basis in the property is $400K ($700K - $300K), so he has $600K total gain. $100K is taxed as ordinary income, $200K is unrecaptured 1250 gain (max rate of 25%) and $300K is taxed as cap gains (max rate of 15%).
Personally, I just let the software figure this crap out…