Selling Rental Property, Tax advice?

Question

I own a townhouse that I moved out of in December 2012, and current tenant is purchasing next month. Since I have not lived there two of the last 5 years, am I correct that I will have to pay capital gains on the difference between what I purchased property for and what I am selling it for? The property has only been a rental for about 2.5 years, but I don't believe that changes anything.

The difference between what I purchased it for and reselling it for is around 15K (after agent commission). Not a huge profit but I would obviously like to keep and reinvest as much as possible. Going to research 1099's since I plan on reinvesting in real estate, but any BP advice greatly appreciated!

Dave Foster · Answer

@James Slaughter,the process of a 1031 starts with the sale of your old property. Prior to that closing a qualified intermediary must be in place to document the transactions and hold and transfer the exchange funds from the sale.

You do not have to have the new property lined up already but from the date of closing of the sale you have 45 days to identify your potential replacements. You have a total of 180 days to complete the transaction. It is perfectly fine to go into contract on your replacement whenever you would like before or after closing of the sale. What is important is that you must close the sale prior to the purchase.

Lynn McGeein · Answer

Not an expert by any means, but we're in process of selling a rental, and my research seems to show that I would owe capital gains on the difference of sales price minus selling fees and the depreciated amount of the property, which can be an issue if the depreciated amount is significantly lower than the loan payoff. Also, on a 1031, it's my understanding that you have a limited time to obtain the same amount in loans and spend the same amount of cash on investment property or will owe the taxes on it, anyway, so not sure we're going that route. I have been waiting to sell some loser stock investments to offset the gains from the house and just completed major renovations on another rental, so hopefully will escape much of the tax bill.

Dave Foster · Answer

@James Slaughter, you can certainly defer the tax on that gain and the associated depreciation recapture by doing a 1031 exchange. You've probably got a 4k - 7K tax bill depending on a lot of variables but when offset against a $700 - 1000 cost of an exchange you would recognize some savings. There are some specific steps you have to take but with the right guidance and keeping focused you can realize those savings.

One other thing for you to research would be the amount of capital improvements you have made over the course of ownership. Those will increase your basis and could make a big dent in the 15k of gain.

James Slaughter · Answer

Thanks @Dave Foster and @Lynn M.. Most of what your saying is pretty much what I thought. One thing I haven't figured out is if you have to have a property purchase lined up before you close, or if you have a set amount of time after you close to reinvest. The tax consequences are not so much that I will be hasty purchasing my next rental, but would sure rather spend money on a kitchen full of new appliances than a check to Uncle Sam. I DID not realize there was a cost for using the 1031, but now that its the weekend, will have time to research further. Thanks again!

Lydia S. · Answer

@James Slaughter

Do you mean 1031's rather than 1099's?

If you plan to reinvest in rentals, why not use a 1031 on this property and defer those taxes?

Russell Brazil · Answer

Yes you will have a capital gain that will be taxes. There will also be some depreciation recapture taxes. @Brandon Hall is a CPA and would have real insight.

Selling Rental Property, Tax advice?

Selling Rental Property, Tax advice?

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