Capital gains avoidance-only if I die and pass to kid?

Question

So 270k baseline in 2000 condo . Rented in year 20 (2021 ) @2350 mo-

I have what account calls "saved" credits on depreciation of 50-75k due to income exceeding 150k annual .

I /(accountant) depreciated my $270,000   rental $10,000 per year for 20 yrs as 1/27 th per year rule.

{Todays baseline is calculated :( 2000 value) $270,000 - total depreciation takenover 20 yrs or  $200,000 = $70,000 dollars current baseline.}

My understanding is currently that on a sale now of $400,000, the capital gains due would be  sale price minus baseline {or $400,000 - $70,000=$330,000 x $20% (i think)}

Using 20% for this =$66,000 tax cap gain due on sale.

I can use the saved depreciation to offset this I am told but if I figure another way I can use the saved unused (50k? approx) depreciation  against any tax due on my return say when i retire and make under 150k.

The only way I found to avoid the $66k cap gains is to die and leave condo to kid, who then has no cap gain tax due, and the kids new  baseline increased to $400k -a reset

Is there another way?

I am 71 , worked hard dealing with a ton of bs renters-and may want to not wait for my "windfall" and i know my wife don't so is this my only option to not give sam 66k ?

Jack Martin · Answer

@Mike Maruska one strategy not mentioned here is to invest in a passive syndication where bonus depreciation will be taken. You may be able to achieve several favorable results with that strategy:

• eliminate (or significantly reduce) the tax event from the sale of the home
• no more dealing with tenants
• estate planning that would allow you to direct proceeds in case you pass away before your wife
• cash flow and appreciation similar or greater than what you have currently

Feel free to PM me to dig deeper.

All the best,

Jack

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Tushar P. · Answer

This is a bad advice. First of all, 500k of new money will need to be dumped into syndications to defer the taxes from the house sale. Secondly, what do you think will happen when the syndication exits after a few years? The taxes due (upon exit) will be higher than the taxes deferred (when the house was sold) because depreciation recapture rate is always higher than the long term capital gains rate.

Dan Schwartz · Answer

@Mike Maruska ask your accountant to determine the tax consequences of selling for you in advance. That’s tax planning.

The depreciation taken (200k) could be taxed at the 25% depreciation recapture rate. That could be $50k in tax right there. There are a number of discussions on BP about when this applies and how to avoid it. Your accountant needs to tell you what scenario applies to you.

The capital gains of $130k, less selling expenses, would be taxed at the 15% rate unless you are in the top marginal tax bracket. In that case, it would be taxed at the 20% rate. Additionally, only you and your accountant will know if these capital gains will trigger NIIT for you.

Your suspended passive losses for this property will be deducted when you dispose of the property. It’s not subject to the $150K AGI cap. If you have multiple passive activities, you have to look first at what suspended losses you have for this particular activity.

There’s an interplay between all of this, and your accountant should be able to determine your potential tax scenarios.  Then you plan to minimize them.

Lastly, don’t forget that if you 1031 into a new property, you will continue to depreciate your current basis on your current schedule. $270,000 worth of your new purchase will be continue to depreciate $10,000 per year for seven more years. The other $200,000 is not depreciable in this scenario. Also, your deferred capital gains of $130k less selling and exchange costs would not be depreciable at all.

Talk to your accountant about your actual numbers, and good luck.

Basit Siddiqi · Answer

@Mike MaruskaIt might not be when you pass away, it depends on who will be inheriting the property.If the property is passed to your wife, the kids will not get the property / step up until she also passes.Another thing to consider if this is a headache property, if you would want her to deal with that issue.Best of luck.

Mike Maruska · Answer

Thanks Tushar and Henry and Jack. I know my direction now. I will probably set up a non revocable trust. The goals would be equitable distribution to the 4 blended marriage kids, fair compensation to the kid who is executor,  and any instructions on whether to demand the 4 properties remain as income for future generations or sold to buy cars, trains and automobiles for the decendants.

Tushar P. · Answer

If 200k depreciation was taken then the cost basis at sale would be 75k (275-200). The gain will be 325k (400-75). For taxes, this 325k will be broken into 2 parts: 200k taxed at depreciation recapture rate (25%) and 125k taxed at long term capital gains rate (15% or 20%).

Depreciation recapture can be avoided by dying. Long term capital gains will not go away just because you moved back into the rental and lived for 2 years. It will be prorated. For example, if you live for 20 yrs after moving in, then 50% of the long term capital gains will be avoided (because both rental and owner occupied durations were equal).

Just remember than uncle scam is smarter than everyone. When people feel great about 1031X and other tax saving/deferring strategies, they are basically doing what uncle scam wants them to do. Because in the long run uncle scam is the winner. You need to discuss your situation with a professional CPA rather than rely on advice here.

Mike Maruska · Answer

Thanks Tushar P. I just looked up that the 200k depreciation will be taxed at a 25% rate or 50k   even if i move back in for 2 years , did I read and understand that correct? and since my baseline started at 275k  and the sale price would be if sold 400k - then 400k minus 200k dep =200k total gain all of which is taxed at 25% requardless if i move in so same tax move in or not ( since she don't want to move in )

Henry Clark · Answer

@Mike Maruska

Michigan is an equitable distribution state.  Your questions above really are estate planning before you get to real estate.  Above can’t be answered without a deep dive into information. As you mentioned look at trusts but understand definition of community property.

Tushar P. · Answer

@Mike Maruska moving back into the rental and selling it after 2 years will not be tax free, even if the gains don’t exceed $500k. Additionally, depreciation recapture would apply irrespective of how long you live in the rental after moving in. Do you really think Uncle Scam is a dummy? Indeed the only way to avoid taxes is to die. If you really want to realize the gains then you will need to pay taxes. Otherwise keep doing 1031X (which means you will never realize the gains ever). As for your situation, just go for the non revocable trust.

Mike Maruska · Answer

Thank you Henry ,Dave and Dan .  Not interested in an exchange as much as transfering to son once I and my wife pass. Fear ( if I pass first) of 2nd wife selling condo and primary , using money   meant for my kids to fund her "new loves" business venture- has caused me to explore a non revokable trust where the trust owns everything and rents while wife 2 is alive is hers but upon her passing each kid gets a house.  That idea is sidetracked and exploring the obvious move back in for 2 years method. So the new question is: Can I sell my condo to my son now, for 400k  thru a land contract say, and upon my dearth forgive the loan assuring he does get the condo instead of gambeling with wife 2 plans or dealing with a trust- would that reset the baseline like my death would-a loan forgiven --his price of 400k would be his baseline no? or would there be another tax gift maybe? i am not familiar with since this is new idea and what would that rate be?

Capital gains avoidance-only if I die and pass to kid?

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