Sell NYC rental property outright vs 1031

10 Replies

Hi everyone,

This is my first post on BiggerPockets :) I am excited to join this community!

I am looking for some advice on tax implications wrt selling my rental property in NYC. I own a rental in the Financial District of Manhattan. It's a bad investment (negative cash flow of around $1200 per month). Therefore I am planning on either selling the property outright and taking the tax hit or doing a 1031 exchange for multiple properties in a more desirable market such as Dallas, TX or Atlanta, GA. I am currently a California resident.

So that I can compare apples to apples, my first step is to calculate the amount of money I'll be able to take home if I sell outright. Can you folks let me know if you see any major issues with my calculations below? I really appreciate you time and help.


Purchase price in May 2007 = $535,000

Estimated sale price = $620,000 (based on conversation with trusted real estate agent)

Net Adjusted Basis = $301,546 (taking depreciation into account which is ($535000/27.5) * 12 years = $233,455)

Costs of Sale (commissions, fees, etc.) = $62,000 (assuming 6% for real estate agent commissions and 4% for other closing costs)

Gross Capital Gain = $256,454

Remaining Mortgage Balance = $330,000

Recaptured Depreciation (at 25% of total depreciation) = $58,363.5

Accumulated Passive Losses to date = $157,000

Net Capital Gains (Gross Cap Gains - Losses) = $99,454

Federal Capital Gains Taxes = $58,363.5 (All from depreciation recapture. $233,455 of Gross Cap Gains account for depreciation and remaining $23,000 of Gross Cap Gains offset by Passive Losses)

Reduction in overall Federal Taxes paid due to remaining Passive losses (assume I pay 25% Federal Taxes on my overall income per year) = $33,500 (there is still $134,000 passive activity loss left after offsetting the $23,000 Gross Cap Gains)

California State Taxes (at 12.3% of Net Cap Gains) = $12,233

Gross equity = $228,000 (Sale price - Cost of Sale - remaining mortgage balance) 

Net Take Home Cash = $228,000 (Gross Equity) - $58,363.5 (Federal Cap Gains Taxes/depreciation recapture) - $12,233 (California Taxes) + $33,500 (Fed tax reduction from remaining passive activity loss to offset ordinary income) = $190,903.

Does the above seem reasonable to you? Am I missing any additional costs? Making any wrong assumptions? 


Thanks again!

-Anand

@Anand George , without doing a deep dive I'd say you've constructed a good working model.  The only thing I'd add to the equation is that you may be making the analysis a little more difficult than you need.  The apples to apples comparison is...

Are you going to reinvest in real estate?  If so then you've got two options - one is to have $190K to spend.  The other is to have $228K to spend.  In both options you are reinvesting.  The only variables are the cost of a 1031 exchange (here'a blog article we wrote for BP - https://www.biggerpockets.com/blog/how-much-does-a-1031-exchange-cost) and your capacity to follow the 1031 regs with a compressed search period.   

Passive losses are great (well sort of until you consider how you got them).  But passive losses are best as an exit strategy.  If you want to reinvest then why bother tapping them now.  $40K invested in property making you 10% is $4K a year real money in your pocket.  Use the 1031 and use deferred tax for your benefit rather than stroking a check to the govt.

I recommend you get a second opinion on the value of your property. The appreciation in 12 years for NYC real estate seems extra conservative unless there are mitigating factors. Also, I think you can negotiate the commission. Good luck!

You're missing NYS and NYC transfer taxes which will come out to about 11-12k. Hopefully you didn't have to pay them if you purchased from the sponsor. Maybe another 3-4k for your attorney and condo fees.

620k sounds like the right asking price, maybe a little optimistic for a final sales price considering active comps and all the available inventory.

@Dave Foster - Thanks for the comparison and for the blog post link - super useful. (My next question was actually going to be about the cost of a 1031 exchange - so you read my mind!). 

So my two options are actually 1) Take the $190K and invest in a diversified stock index or 2) Take the $228K and reinvest in real estate. I figured the bigger the difference in cost between the two, the more likely it is that I'll go with the second (reinvesting in real estate) option. If you see any glaring issues with my general calculation that'll change the numbers significantly, it'd be great if you can let me know.

@Ahmed Saad - Thanks for the suggestion. I was hoping my apartment would have appreciated more as well in the last 12 years ;) However, as @Jason Lee points out, the estimate is actually in line with units on the market. There is a very similar unit in the building listed for $620K.

@Jason Lee - Thanks so much for raising the additional cost with the NYC/NYS transfer taxes and attorney/condo fees. I didn't realize these were part of the transaction costs (especially the transfer taxes). Do you think these costs are on top of my estimated 10% closing costs/agent fees or are these part of that 10%? 

And yes, you are correct, luckily I didn't have to pay the transfer taxes initially since I bought from the sponsor.

Are there any other costs I am not accounting for? I figured I don't have to account for capital gains tax to NYC/NYS since the California tax rate is higher.

Thanks,

Anand

Oh I missed the other 4% for closing costs. That would typically include the transfer taxes.

FYI it's customary for the seller to pay the transfer taxes EXCEPT from a sponsor, in which case it's customary for the buyer to pay. So you often get hit with the taxes going in and out at a new development. In slow markets it's negotiable, so it's possible you might have paid them going in.

Would anyone be willing to add a couple more descriptions on this analysis?  Couldn't figure out how there were arrived.

Net Adjusted Basis = $301,546?

Gross Capital Gain = $256,454?

Accumulated Passive Losses to date = $157,000 (were these accumulated over the 12 years?)

Why are you paying California state taxes if the property is in NY? 

I've never sold a rental property but am thinking about it.  Should I expect to pay a tax expert to give me a more accurate sense of my situation?  Would be nice to be able to figure it out myself but not feeling so great after not understanding most of this analysis.  

If the properties are in NC and Mich but I live in NYC, should I expect to pay NYC taxes of Net Property gains?  

Thx.  

"Fed tax reduction from remaining passive activity loss to offset ordinary income" - How does one calculate this?  Thx..