Selling a property and confused with capital gains

Rental Property Investor · New York, NY · Member since 2011 · 95 posts · 10 votes

Hello fellow investors.

I had a question. I am selling an investment property and wanted to understand capital gains correctly. When I purchased the property I put down 25% downpayment of my own money + closing costs.

Then came closing costs for the sale of the same property along with realtor commission.

Question is will I pay capital gains on it all or just what is left after all the deductions mentioned above?

Also wondering what to do with the money - 1031 exchange or take advantage of the new tax law with opportunity zones.

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Dennis Maynard

Real Estate Broker · Los Angeles, CA · Member since 2018 · 300 posts · 146 votes

I can't answer opportunity zones. The regulations are still forthcoming. Frankly, I'm still figuring it out myself. It really depends on how much you are playing with and what your goals are.

Capital gains = Sale Price - Purchase price - cost of acquistion and sale - improvements

If you are 1031, you don't need to concern yourself right now with it. Just use the formula above for a general guideline.

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Dennis Maynard
Real Estate Broker · Los Angeles, CA · Member since 2018 · 300 posts · 146 votes
7y
I can't answer opportunity zones. The regulations are still forthcoming. Frankly, I'm still figuring it out myself. It really depends on how much you are playing with and what your goals are.
Capital gains = Sale Price - Purchase price - cost of acquistion and sale - improvements
If you are 1031, you don't need to concern yourself right now with it. Just use the formula above for a general guideline.
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Matthew Ryan
Developer · San Francisco, CA · Member since 2015 · 103 posts · 47 votes
7y
@Raza Rizvi Opportunity Zones would be a good fit depending on how large your capital gain is. Your capital gain is simply put: your profit. As far as recapture on the depreciation, I can't speak to that but can put you in touch with someone who does. 1031 exchange is good and I've completed one myself: the problem is getting a couple of deals T'd up in time: Identifying your 3 properties in the 45 days and closing on one of the 3 you identify within 180 days. OZ's give you more flexibility on how soon you have to invest (180 days from the capital event). There are additional conditions around OZ's but the one stand out thing from 1031's is if you keep the investment in OZ's for the full ten years, you pay zero capital gains when you sell, period. You can DM if you'd like more details.
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Raza Rizvi
OP
Rental Property Investor · New York, NY · Member since 2011 · 95 posts · 10 votes
7y
@Dennis Maynard Thanks for your reply. Does my initial down payment count towards the cost of acquisition?
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Raza Rizvi
OP
Rental Property Investor · New York, NY · Member since 2011 · 95 posts · 10 votes
7y
@Matthew Ryan thanks for your feedback. I found this to be helpful
https://www.irs.gov/newsroom/opportunity-zones-frequently-asked-questions
If I opt out of 1031, all I need to invest in the Opportunity fund will be the gains. The initial downpayment etc. I can still cash out? Correct? Or am I missing something
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Dennis Maynard
Real Estate Broker · Los Angeles, CA · Member since 2018 · 300 posts · 146 votes
7y
Originally posted by @Raza Rizvi:

@Dennis Maynard Thanks for your reply. Does my initial down payment count towards the cost of acquisition?
No it's separate. It is not included in the profit anyway.
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Dave FosterBusiness Member
Qualified Intermediary for 1031 Exchanges · St. Petersburg, FL · Member since 2013 · 9k+ posts · 9k+ votes
7y
@Raza Rizvi, There's one more component to gain in addition to what @Dennis Maynard gave you that can be a huge determining factor on whether to simply cash out or to go the QOZ or 1031 route. And that is depreciation recapture. Your gain is the difference between your adjusted Cost basis and your net sale (the sales price minus closing costs. Adjusted cost basis is determined by starting with your acquisition price +capital improvements - depreciation. This is subtracted from the the net sale and that is your gain.
And the gain is made of two components - gain and depreciation. You pay 15 or 20% on the gain. But you pay 25% on the depreciation recapture. So if you've owned the property for some time the depreciation recapture could be very significant. Doing that calculation will give you a good idea of whether you can simply take the cash or need to look for tax mitigation through a 1031 or opportunity zone.
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Tanner Crawley
Realtor · Lone Tree, CO · Member since 2017 · 139 posts · 112 votes
7y
@Raza Rizvi
"If I opt out of 1031, all I need to invest in the Opportunity fund will be the gains. The initial downpayment etc. I can still cash out? Correct? Or am I missing something"

This is correct. You can reinvest only the capital gains portion into an opportunity fund. The OZ route makes a lot of sense, but as @Dave Foster said you should consider Recapture as well.

I also don't think Matthew mentioned this regarding OZones but you can only defer your original capital gain until December 2026 (Although the gain is reduced 15%). It is the gains made after the OZ investment that are tax exempt.

1031's are probably more powerful but really the best strategy is just to defer until you die and you can never really recognize the gain in a tax-friendly way. With Opportunity Zones you could have tax free gains until 2048. Then recognize the gain with zero taxes for portfolio rebalancing.
1031's will also likely be a bit more complicated with higher fees. Are you an accredited investor?
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Dennis Maynard
Real Estate Broker · Los Angeles, CA · Member since 2018 · 300 posts · 146 votes
7y
@Dave Foster Dave is correct so long as you took depreciation. This is the importance of using an accountant that understands real estate investments. I have had clients that cannot take depreciation as it impacts their bottom line negatively personally. Dave also is correct on the recapture. However there is one component we all forgot to mention, time. How long you have held the property will affect your tax rate on gains. Two years is the marker between long term and short term capital gains. Hope this helps. I'm sure there will be more comments.
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Dave FosterBusiness Member
Qualified Intermediary for 1031 Exchanges · St. Petersburg, FL · Member since 2013 · 9k+ posts · 9k+ votes
7y
Thanks @Dennis Maynard, and of course one more gotcha - It doesn't matter whether or not you actually took the depreciation when offered. Recapture is required for appreciation taken or that could have been taken. So it' doesn't matter if you took the benefit at all. You still have to pay it back - nice gift huh!
BTW - once ownership crosses the one year mark it becomes a capital gain vs ordinary income
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Matthew Ryan
Developer · San Francisco, CA · Member since 2015 · 103 posts · 47 votes
7y
Originally posted by @Raza Rizvi:

@Matthew Ryan thanks for your feedback. I found this to be helpful
https://www.irs.gov/newsroom/opportunity-zones-frequently-asked-questions
If I opt out of 1031, all I need to invest in the Opportunity fund will be the gains. The initial downpayment etc. I can still cash out? Correct? Or am I missing something
The only thing eligible for tax deferral under OZ's is the gain itself, Yes.
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