Selling Investment Rental Property:Tax avoidance options and 1031

4 Replies

We are contemplating selling one of our investment rental properties in a profitable market, and intend to encash all money.

We had below queries:
Sell Price = Initial Principal Downpayment + Loan + Closing Cost + Taxes - Depreciation + Capital Gains

1. Are Taxes based ONLY on Capital Gains or (Principal Downpayment + Capital Gains)?

2. 1031 Like-Kind Exchange:
- Is it possible if we cash-out Initial Principal Money AND use Only Capital-Gains, as part of 1031 like-kind exchange, to purchase new investment property.

3. Can Capital Gains be used to pay mortgage debt for my another CURRENT investment-property as part of 1031 like-kind exchange?
-And, cash-out Initial Principal money.

Thank you in advance.

@Andy NA

Your property's basis is calculated as: Purchase price + capitalized improvements - depreciation

Your capital gains are calculated as: Sales price - Basis (above) - selling costs

1. Taxes are calculated based on the capital gains calculation described above, at the capital gains tax rate

2. You can do that, however, you will be taxed on the initial down payment.  The IRS requires any CASH that comes from a sale to be reinvested.  Meaning, your lender will be paid back as part of the sale, so you are left with your capital gain, original cash invested, and any equity pay down left as cash.  You can split it up, but would be taxed on the non-exchanged portion.

3. Nope, but you might be thinking of a reverse 1031?  You would have had to work with an intermediary for the existing property.

Hope this helps!

@Andy NA

1. You will be taxed on the capital gain and the depreciation recapture.

2. When you do a 1031 what you call initial investment the IRS calls profit.  They say the first dollar you pull out is profit.  So as @Jennifer B. says you can take money out of a 1031 but it is taxable.

3. You cannot exchange for a property you already own. You cannot 1031 and pay down the mortgage on a property you own. 

Andy NA As mentioned above, your tax liability is going to be the difference between your current cost basis and net sales price.

You can choose to pull money out of your sale when completing a 1031. We call that a partial exchange. Be aware that one of the requirements when completing a 100% tax deferred exchange is that you replace all debt and equity from the property you sold and trade equal or up in value. Therefore, if you pull money out you will be responsible for tax and/or depreciation recapture liability. What you do with the funds withdrawn are up to you. They certainly can be used to pay down a mortgage on another investment property but again, whatever amount you don’t reinvest will be taxed.

Let me know if you’d like to discuss further.

Hey Andy

I know of a great way investors are locking in their profits on 1031 exchange properties and deferring the tax.  It is through a few large institutions that are collecting money through investors and putting together portfolios for them.  All cap gains are tax deferred and they even pay you a monthly dividend on the portfolio.  End of year you get 1099, and this is still partially written off because they write off losses in the portfolio. Pretty cool stuff.

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