Capital gains tax based on income?

Question

I bought a condo in 2015 and lived in it for less than two years and then rented it out for a couple years. This was all before I found BP and knew anything about real estate investing. Once I joined the community and started looking into RE investing, I realized I had to sell it because it wasn't cash flowing and I was actually losing money. However, it did appreciate and I made some money on the deal. I didn't put it into a 1031 right away, and I don't know if I can still can (I sold it about 6 months ago), and I'm worried I'll be taxed for capital gains on it. However, I make less than $37k a year and from the research I've done, I fall into the 0% capital gains bracket because of that.

Can anyone tell me if I am correct or is it more nuanced than that? I've thought about reaching out to a CPA, but if it's as simple as the research I've done makes it out to be, I don't want to waste the money.

Thanks in advance for any advice!

Can anyone tell me if I am correct or is it more nuanced than that? I've thought about reaching out to a CPA, but if it's as simple as the research I've done makes it out to be, I don't want to waste the money.

Thanks in advance for any advice!

Natalie Kolodij · Answer

When you convert a primary residence to a rental it's basis is the LOWER of FMV at time of conversion or original purchase price.

So his basis would not have stepped up to FMV.

IRS Pub 551

Natalie Kolodij · Answer

It's too late for a 1031.

You mention you occupied it less than 2 years- and then rented for a few years.

What is the actual timeline? And why did you move out? You still may qualify for  a partial 121 exclusion.

If not, capital gains are based on your tax bracket but the GAIN goes into your income calculation. So your income is $35k now and 0%- but add in the $X  worth of gain and you're likely in the 15% bracket.

Your gain will be based on sales price - selling expenses - adjusted basis. And any amount of the gain that was generated from depreciation will be taxed at your ordinary rate up to 25%

I would reach out to a tax pro to make sure this is all being handled correctly on the sale.

Dave Foster · Answer

@Matt Carozza, Your 1031 must be in place prior to the sale.  So once you closed on the sale without a 1031 intermediary in place you recognized the gain.

If your income is less than level mentioned by @Josh Dixon then the cap gains rate is 0.  But your sale could impact that taxable income.  So do check with a CPA so you have time to plan accordingly.

Josh Dixon · Answer

Hi Matt,

I would probably look into getting a CPA. I don't think you will have much gain, but it might be good just to make sure it all gets reported correctly. Your basis would have increased to the fair market value of the property at the time that you started renting it, and you would also be able to include any selling costs to reduce your gain. You will have some depreciation recapture (whether you reported depreciation each year or not) and that will get taxed at your ordinary tax rate. If you weren't taking it, then there is a way to catch-up that depreciation, so they can offset.

The capital gain tax rate (if you have any gains) should be based on your taxable income, which is your income minus the standard deduction or itemized deductions whichever you do. But any gain and depreciation recapture do get added to your income in determining where you fall in the range. I think you'll still be ok, but based on the income amount you gave, it sounds like you are single and the 0% CG ends at $39,375 so you are kind of on the bubble.

If you do end up with some capital gains, it may end up being 15% if not 0%, but I'm not sure it would be worth doing a 1031 for little to no gain even at 15%, and you only have 6 months (180 days) to complete it so you are probably out of time anyway.

Hope this helps! If you need me to explain something more/different, just let me know.

Mark Creason · Answer

@Matt Carozza

You may be at a 0 cap gain on your deal, but if not, you could potentially invest in an opportunity zone fund.  You would have to accomplish this within 180 days of your close.

Mark

Natalie Kolodij · Answer

You've just got to be careful on BP because people lookup questions related to REI tax stuff and find answers on here. If the answer is wrong then that info spreads.

That's happened with a few blogs/ posts/ ect over the years- Always better to provide a more general answer than go into details if it's not something you're 10000% sure on because people assume everything on the internet is fact.

Josh Dixon · Answer

Thank you Natalie and Steven for setting me straight, I havent done a rental conversion in a while and didnt look it up before commenting. I didnt realize this was a technical question, I thought he was asking whether to get a CPA or not. His post had sat for 5 hours with no comments and I thought I would make a suggestion for him to get some help (obviously not me).

Natalie Kolodij · Answer

In this example it happens to be less.

But if we take his house value when he bought it in 2015 (excluding land value separated out)

And look at the house value today it's FMV

What makes you think it was worth more several years ago in the current market?

You split out land at both points in time for the adjusted basis and the current FMV. Houses have gone up in value 99% of the time over the last several years.

And again, you said "your basis would have increased to the FMV". If the FMV today was higher- his original house basis is what would be used. Lower of the two.

Steven Hamilton II · Answer

Dude, Natalie is correct. It never increases to FMV except on date of death. It is possible it is lower due to FMV. You directly contradicted yourself.

Anthony J. Faso · Answer

I am a "recovering" CPA and Josh Dixon and Natalie Kolodij are right on.  You will need to claim the sale on your tax return however the gain would be taxed at 0% . I would highly recommend you work with a CPA.  Natalie Kolodij is very knowledgeable and an expert in RE

Capital gains tax based on income?

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