Seller Tax Implications

[Gary Parker]

I will potentially be purchasing a property sub2 the existing mortgage of $92,000.00, property worth $125K as is, seller says depreciated to $0, I will give a $10K note balloon due 10 years @ 0% interest and $100 a month for ?. Of course I will make the payment on the $92K. I will hold the property as a rental for the foreseeable future. Not 100% sure of the structure for the sale yet as far as using a note & trust deed, option, contract for deed etc. I have not even considered the new lending regulations.

What are the possible tax consequences with a sale in this manor?

[Dave Toelkes]

@Gary Parker

The seller could have (an almost) correct understanding of the tax treatment, but because we don't know how much of the $92K contract price is depreciation recapture and how much is long term capital gain due to appreciation, we can't really give you a definitive answer.

Let's just assume that the seller purchased this property many years ago since it is depreciated to $0 and let's also assume that the seller's depreciation basis was $92K. In this case, all of the gain on the sale will be due to unrecaptured depreciation and taxed at 25% (a bit higher than the long term capital gains tax rate). Unrecaptured depreciation is taxable in full in the year of the sale, even if the property is sold on installments.

If the seller's original depreciation basis was just $35K, then the seller's $35K unrecaptured depreciation will be taxed in full in the year of the sale. If sold on an installment sale, the balance of the purchase price ($57K if sold at $92) will be taxed only when received at the long term capital gains tax rate in effect for the tax year in which installments are received.

Neither scenario above considers the land value. It is unlikely that the property is depreciated to $0 since the land under the dwelling structure can not be depreciated. This land has some cost basis, and the portion of your purchase price that represents a capital gain on the sale of the land itself will be subject to long term capital gains tax as the installments are received. No depreciation recapture applies to the land.

I am guessing that the seller refinanced his property a few years ago and cashed out his equity. The equity has been spent and now the seller may not have the cash in reserve to pay the IRS. The seller may decide that he can't afford to sell without a high enough cash down payment to cover the income tax bill.

In your position, I would not tell the seller what his tax treatment would be. You are right to strongly suggest that the seller get this information from his own tax pro.