Capital Gains - Simplified

[Samuel DeMass]

Hey BP,

I'm having a hard time visualizing the taxable capital gains on the backside of owning a property.

Here's an example to help simplify my question:

What gets taxed when you sell a property?

Lets assume the property was bought for 100K and financed at @ 80%.  You've enjoyed the depreciation tax benefits for 10 years, but now you're ready to sell it.

You sell the property for 150K and the loan payoff is 50K, leaving a simple 100K difference.

What is the total taxable amount from the sale, assuming standard depreciation was used?

Thank you for your time.

-Sam

[Jon Holdman]

I'll repeat @Kenneth LaVoie's statement the loan doesn't come into play.  However, interest on a loan is a deductible expense.  That includes points, and those may come into play for calculating taxes in some situations.  But the loan balance doesn't affect the taxes owed. Its entirely possible to buy, refi, and sell and end up bring cash to the closing table to sell and STILL have a tax bill.

Here's the details of the calculation. I'm making the usual assumption that the value of the improvements are 80% of the price you paid.  There are better ways to compute this.  Closing costs on both the sale and purchase also factor into the calculation.

1) purchase price plus your closing costs is your initial basis.

purchase price $100,000.00

purchase costs $2,000.00

initial basis $102,000.00

2) depreciation reduces your basis

value of improvements $80,000.00

annual depreciation $2,909.09

depreciation after 10 years $29,090.91

basis after 10 years $72,909.09

3) closing costs on the sale reduce your net return from the sale

selling price $150,000.00

selling costs $3,000.00

net selling price $147,000.00

4) net selling price less your basis is the total gain

total gain $74,090.91

5) the gain is now split into unrecaptured depreciation and capital gains

uncaptured depreciation $29,090.91

cap gain $45,000.00

6) And the tax is computed on each

recapture rate 25%

cap gains rate 15%

recap tax $7,272.73

capital gains tax $6,750.00

7) add them up to get the total tax bill

total tax $14,022.73

Do notice that each year you had a deduction of just under $3000.  This is often touted as a "tax benefit" and naive buyers are told you can deduct this against ordinary income.  That may or may not be true, depending on several factors.  If its not, and it's not for a lot of rental investors, then this deductions you cannot take as you hold the property become "carry forward passive losses".  Then when you sell a property, you can use those carry forward passive losses to offset the gains on the sale.  If you have a portfolio of properties, you can use the carry forward losses from all of them to offset the gains on a sale of just one.