Huge tax shock that came back to haunt me.

I'm a little confused with this fact set can you elaborate?

OP

Investor · Comstock Park, MI · Member since 2015 · 54 posts · 14 votes

2y

I bought the house for $63k. After the last refi the new mortgage loan was $170k and sold the house for $270k so I thought I was going to owe on a gain of $100k but she says I'll owe on a $180 gain because she's calculating on all 3 gains. These are just round number but close. Not counting closing cost and other fees.

Jonathan Bock

Accountant · Bryn Mawr, PA · Member since 2023 · 409 posts · 321 votes

2y

This is another example of why I advocate for tax planning not just transactional compliance work.

You can't blame your preparer they are simply reporting a transaction and I'm guessing you didn't consult with anybody before you sold the property?

2 Reply

OP

Investor · Comstock Park, MI · Member since 2015 · 54 posts · 14 votes

2y

I did ask her about selling the house about a year ago but she didn't know about the refi's.

Lynn McGeein

Real Estate Agent · Virginia Beach, VA · Member since 2012 · 2k+ posts · 1k+ votes

2y

It sounds like she may be trying to explain that you purchased in 2012 for 63K, which would have been depreciated until now, then sold for $270K, so you'd owe gains on the difference between the depreciated purchase price and the $270K you sold it for, which she says is $180K, no matter how many times you pulled cash out in a refinance. I don't think taking cash out in refinance raises your cost basis to calculate your taxable gains at sale unless you used the cash-out refi for an addition to the house. I'm not an accountant, so could be wrong, but I think you're confused because it sounds like you're thinking that your cash-out refis somehow provided you with tax-free profit for the amounts you pulled out?

3 Reply

OP

Investor · Comstock Park, MI · Member since 2015 · 54 posts · 14 votes

2y

Quote from @Lynn McGeein:

It sounds like she may be trying to explain that you purchased in 2012 for 63K, which would have been depreciated until now, then sold for $270K, so you'd owe gains on the difference between the depreciated purchase price and the $270K you sold it for, which she says is $180K, no matter how many times you pulled cash out in a refinance. I don't think taking cash out in refinance raises your cost basis to calculate your taxable gains at sale unless you used the cash-out refi for an addition to the house. I'm not an accountant, so could be wrong, but I think you're confused because it sounds like you're thinking that your cash-out refis somehow provided you with tax-free profit for the amounts you pulled out?

Yes, that's exactly what my accountant said. I was just mislead into thinking that if my mortgage when sold was $170 and I sold it for $270 that my gain was only $100. But you are right, and she's right. I think I'm just going to write that check and use it as a learning experience.

Matt Devincenzo

Investor · Clairemont, CA · Member since 2011 · 3k+ posts · 2k+ votes

2y

You're not the first to post about this on these forums, and I'm sure you won't be the last. I wouldn't consider this an issue though, you used tax 'deferred' refi dollars to purchase other assets at seemingly good times/prices etc. Now your 'deferral' has come due and you need to pay the tax. Doing this likely compounded your gains in the other properties since you were able to buy with dollars that weren't getting taxed as you received them. That's part of the win in this lesson learned.

4 Reply

John Clark

Member since 2018 · 1k+ posts · 1k+ votes

2y

Quote from @Account Closed:

That sounds like a major headache, Sean! It's a tough lesson, but yeah, tax implications can be sneaky. Maybe a tax pro could help you navigate this mess and find any possible deductions or offsets. And thanks for sharing your experience—it's definitely a wakeup call for others eyeing similar moves.

Nothing sneaky about it. Pulling money out doesn’t affect the cost of purchase, nor the cost of sale. Capital gains is the difference between the two.

Here’s a thought experiment for you: Owner buys Blackacre on day 1 for $100. He refinances on day 999 and pulls $999,999 out. He sells on day 1,000 for $1 million. Could anyone say with a straight face that he only owes capital gains tax on just the one dollar increase in value between days 999 and 1,000?

I got dollars to doughnuts the original poster did not pay tax on the money he pulled out for the two refinancings, so how can he be “haunted” now?

6 Reply

Michael PlaksPro Member

Tax Accountant / Enrolled Agent · Houston, TX · Member since 2014 · 5k+ posts · 6k+ votes

2y

As other people already said, your accountant is correct.

While I understand your frustration, it really was not economically sensible to expect a different result. If you bought a house for $63k and sold it for $270k, and you have NEVER paid any taxes on this house appreciation - why would you expect this gain in value to be tax-free in the end?

Where I'm not with your accountant is in her failure to alert you that you had an option to defer this capital gain via a tax strategy known as 1031 Exchange. But it had to be structured before you sold the property, so it's too late now.

And there were other options to deal with your capital gain, but they are also too late to pursue now.

Lesson for everyone: You save taxes by planning forward, not after the fact. Work with an experienced tax planner/strategist specializing in real estate and not merely a general tax preparer. It costs more, but it's so worth it. This forum features 20+ of us.

Consolation: an excellent point made by @Matt Devincenzo that you DID benefit greatly from being able to refi (and twice!) without paying taxes and deploy your tax savings towards growing your wealth. Yes, these savings were temporary but nevertheless valuable.

8 Reply

OP

Investor · Comstock Park, MI · Member since 2015 · 54 posts · 14 votes

2y

Quote from @Michael Plaks:

Podcast Guest on Show #222

As other people already said, your accountant is correct.

While I understand your frustration, it really was not economically sensible to expect a different result. If you bought a house for $63k and sold it for $270k, and you have NEVER paid any taxes on this house appreciation - why would you expect this gain in value to be tax-free in the end?

Where I'm not with your accountant is in her failure to alert you that you had an option to defer this capital gain via a tax strategy known as 1031 Exchange. But it had to be structured before you sold the property, so it's too late now.

And there were other options to deal with your capital gain, but they are also too late to pursue now.

Lesson for everyone: You save taxes by planning forward, not after the fact. Work with an experienced tax planner/strategist specializing in real estate and not merely a general tax preparer. It costs more, but it's so worth it. This forum features 20+ of us.

Consolation: an excellent point made by @Matt Devincenzo that you DID benefit greatly from being able to refi (and twice!) without paying taxes and deploy your tax savings towards growing your wealth. Yes, these savings were temporary but nevertheless valuable.

Just finished listening to another BP podcast about a caller that wants to buy another rental property but isn't sure how. He has a ton of equity in another rental so they suggested to do a cash out refi to buy another (sounds familiar). Out of the 10+ years I've been listening to all these podcast there is a part 2 they never talk about . . . selling said property, other than 1031 or doing a land contract AKA seller financing to avoid these gains. Yes, I could have done a 1031 but since the market is still over priced, my gain wasn't even enough for a down payment on something of equal or greater value so I had to take the hit. I just didn't realize it was going to be that huge. I'm just happy that my wife doesn't make me sleep on the couch.

In the future, before I do any refi's, HELOCs or selling of any properties I will definitely be talking to my CPA first.

Thanks everyone for your help. Sometimes it helps to bounce things off the community and maybe help future investors too.

2 Reply

Jay HinrichsBusiness Member

Real Estate Consultant · Summerlin, NV · Member since 2014 · 45k+ posts · 66k+ votes

2y

Quote from @Account Closed:

That sounds like a major headache, Sean! It's a tough lesson, but yeah, tax implications can be sneaky. Maybe a tax pro could help you navigate this mess and find any possible deductions or offsets. And thanks for sharing your experience—it's definitely a wakeup call for others eyeing similar moves.

refi does not change basis.. so not sure where the shock is here.. other than most folks probably would have done a 1031 to roll up and not pay the tax.. but hey you bought for 63k and sold for 270k and netted out a very nice gain whats to complain about.. ??

JLH Capital Partners51 Review

Website View Page

3 Reply

Jay HinrichsBusiness Member

Real Estate Consultant · Summerlin, NV · Member since 2014 · 45k+ posts · 66k+ votes

2y

Quote from @Sean N.:

Quote from @Michael Plaks:

Podcast Guest on Show #222

As other people already said, your accountant is correct.

While I understand your frustration, it really was not economically sensible to expect a different result. If you bought a house for $63k and sold it for $270k, and you have NEVER paid any taxes on this house appreciation - why would you expect this gain in value to be tax-free in the end?

Where I'm not with your accountant is in her failure to alert you that you had an option to defer this capital gain via a tax strategy known as 1031 Exchange. But it had to be structured before you sold the property, so it's too late now.

And there were other options to deal with your capital gain, but they are also too late to pursue now.

Lesson for everyone: You save taxes by planning forward, not after the fact. Work with an experienced tax planner/strategist specializing in real estate and not merely a general tax preparer. It costs more, but it's so worth it. This forum features 20+ of us.

Consolation: an excellent point made by @Matt Devincenzo that you DID benefit greatly from being able to refi (and twice!) without paying taxes and deploy your tax savings towards growing your wealth. Yes, these savings were temporary but nevertheless valuable.

Just finished listening to another BP podcast about a caller that wants to buy another rental property but isn't sure how. He has a ton of equity in another rental so they suggested to do a cash out refi to buy another (sounds familiar). Out of the 10+ years I've been listening to all these podcast there is a part 2 they never talk about . . . selling said property, other than 1031 or doing a land contract AKA seller financing to avoid these gains. Yes, I could have done a 1031 but since the market is still over priced, my gain wasn't even enough for a down payment on something of equal or greater value so I had to take the hit. I just didn't realize it was going to be that huge. I'm just happy that my wife doesn't make me sleep on the couch.

In the future, before I do any refi's, HELOCs or selling of any properties I will definitely be talking to my CPA first.

Thanks everyone for your help. Sometimes it helps to bounce things off the community and maybe help future investors too.

it does not matter if you did a refi or not.. the gain is the gain. you were blessed with a great investment enjoy it.

JLH Capital Partners51 Review

Website View Page

3 Reply

Account Closed

Accountant · San Diego, CA · Member since 2019 · 1k+ posts · 552 votes

2y

Quote from @Michael Plaks:

As other people already said, your accountant is correct.

While I understand your frustration, it really was not economically sensible to expect a different result. If you bought a house for $63k and sold it for $270k, and you have NEVER paid any taxes on this house appreciation - why would you expect this gain in value to be tax-free in the end?

Where I'm not with your accountant is in her failure to alert you that you had an option to defer this capital gain via a tax strategy known as 1031 Exchange. But it had to be structured before you sold the property, so it's too late now.

And there were other options to deal with your capital gain, but they are also too late to pursue now.

Lesson for everyone: You save taxes by planning forward, not after the fact. Work with an experienced tax planner/strategist specializing in real estate and not merely a general tax preparer. It costs more, but it's so worth it. This forum features 20+ of us.

Consolation: an excellent point made by @Matt Devincenzo that you DID benefit greatly from being able to refi (and twice!) without paying taxes and deploy your tax savings towards growing your wealth. Yes, these savings were temporary but nevertheless valuable.

Just would like to add two things to this since everyone else did a great job explaining it:

When selling, try to find a place to put that money that ideally offsets the capital gains. For example, a real estate syndication project that generates passive losses year one could do this. I personally like the strategy of "kicking it down the road" over and over until you die.

Another area that could have a similar surprise as this post is depreciation recapture. Many are shocked when they go to sell and realize they have a much larger gain they have to pay tax on than they thought because their basis in the property is so low due to deprecation.

Benjamin WeinhartBusiness Member

Accountant · Cincinnati OH 45245, USA · Member since 2022 · 112 posts · 112 votes

2y

I feel I have something more to add more conceptually that may help people reading this in the future to see that this can be a great strategy to deploy. I agree that the gain could have potentially been offset by utilizing various different methods such as a Sec. 1031 exchange, but this would've just kicked the tax can down the road further (except for death which is a whole other topic).

I wanted to mention that strategies just like these are commonly utilized by the ultra wealthy in order to do a number of different things. I commonly hear in the media about, for example, Elon Musk taking a large amount of personal debt to finance his deal with Twitter. He could have easily sold his Tesla shares instead to fund the deal, but by taking on debt and using them as collateral, one of the things he is doing is avoiding the taxable event that would otherwise happen if he sold the stock, and getting what is probably an extremely low interest rate for the loan. Other people may do deals like these to just fund their lifestyle/passion projects. Just some examples of how effective tax planning can really come in handy as you may start scaling up further.

[email protected]

Ice Accounting & CPA, LLC55 Reviews

View Page

Bill B.

Investor · Las Vegas, NV · Member since 2013 · 8k+ posts · 10k+ votes

2y

If you sold for $270k and received $250k after selling costs then paid $50k in state and local in some tax you only received $200k. Why didn’t you just do another cash out refi for $200k tax free?

If the property was a pain in your butt next time research the 1031. Otherwise hold it until you die and all the taxes go away.

Ps. Don’t forget that property bought you other 2 rentals that you still haven’t paid taxes on. You are waaaaaay ahead of the game in both investing and taxes.