Cash out refinance-do you pay capital gains

Tax, SDIRAs & Cost Segregation
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Cash out refinance-do you pay capital gains

Ben Szafran
Real Estate Broker · Wilmington NC · Member since 2020 · 33 posts · 21 votes

I just cash out refinanced a rental home so I could buy a partner out of the property.  I was the only person on the loan to start with, and I am the only entity on the loan now. I paid the partner out-does he pay captial gains tax on the earnings?  My understanding is no taxes to pay.  Any advice welcome.  (by the way I wrote my CPA, but he is out of town for the long weekend)

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Basit SiddiqiBusiness Member
Accountant · New York, NY · Member since 2015 · 8k+ posts · 3k+ votes
1y

You 'potentially' created an issue depending on how you are reporting it for tax purposes.

How were you reporting this activity with a 'partner'.
Was this done through a partnership return?
Was it done by only reporting your share on schedule E?

The thing I want to bring to your attention is how you will report the additional basis for buying out your partner.
When you sell the property, you want to make sure you are factoring in your buyout.

Some discussions to have with your CPA.

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  • Matt Devincenzo
    Investor · Clairemont, CA · Member since 2011 · 3k+ posts · 2k+ votes
    1y

    You've got the wrong question...

    Did you buy out your partner's ownership in the LLC, or his interest in the real property? It sounds like LLC membership, meaning he sold you an asset. You did a cash out, so you don't owe any tax but those proceeds were used to buy his ownership. Since he did sell something, then he likely owes taxes and you now get a basis equal to what you paid for his portion of the property.

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  • Ben Szafran
    OP
    Real Estate Broker · Wilmington NC · Member since 2020 · 33 posts · 21 votes
    1y

    Hi Matt,

    The property was owned in individual names. The loan was in my name, I was the personal guarantor. The partner was only on the deed. I did the refinance and put the new loan into my investment LLC.

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  • Ben Szafran
    OP
    Real Estate Broker · Wilmington NC · Member since 2020 · 33 posts · 21 votes
    1y

    I see what you are saying also

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  • Aaron ZimmermanBusiness Member
    Accountant · Chicago, IL · Member since 2018 · 2k+ posts · 1k+ votes
    1y

    How was the property reported on your respective returns?

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  • Matt Devincenzo
    Investor · Clairemont, CA · Member since 2011 · 3k+ posts · 2k+ votes
    1y

    I'm not a tax pro, so obviously other details could change a professional evaluation here. But it sounds like your partner 'sold' real property and has a tax consequence, and you bought that property. So your old 50% basis plus this new 50% basis is your entire basis in the property by itself going forward. 

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  • Basit SiddiqiBusiness Member
    Accountant · New York, NY · Member since 2015 · 8k+ posts · 3k+ votes
    1y

    You 'potentially' created an issue depending on how you are reporting it for tax purposes.

    How were you reporting this activity with a 'partner'.
    Was this done through a partnership return?
    Was it done by only reporting your share on schedule E?

    The thing I want to bring to your attention is how you will report the additional basis for buying out your partner.
    When you sell the property, you want to make sure you are factoring in your buyout.

    Some discussions to have with your CPA.

    [email protected]917-280-8544
    Basit Siddiqi CPA4.979 Reviews
    View Page
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  • Jason MalabuteBusiness Member
    Accountant · Los Angeles, CA · Member since 2016 · 2k+ posts · 901 votes
    1y


    How exactly were you reporting things with your partner? Was this being filed as a partnership return, or were you just reporting your portion on Schedule E?

    The main point to keep in mind is how you’ll handle reporting the extra basis from buying out your partner. When it comes time to sell the property, you want to make sure that added basis is factored into the calculation.

    Definitely something worth clarifying with your CPA so it’s handled correctly.

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  • Michael PlaksPro Member
    Tax Accountant / Enrolled Agent · Houston, TX · Member since 2014 · 5k+ posts · 6k+ votes
    1y
    Quote from @Ben Szafran:

    I just cash out refinanced a rental home so I could buy a partner out of the property.  I was the only person on the loan to start with, and I am the only entity on the loan now. I paid the partner out-does he pay captial gains tax on the earnings?  My understanding is no taxes to pay.  Any advice welcome.  (by the way I wrote my CPA, but he is out of town for the long weekend)

    You're describing it like an investor presenting his deal at an REI meetup, with a superficial overview, happy ending and a slightly intoxicated crowd cheering on you. Taxes however require clarity on what actually happened.

    1. "I just cashed out refinanced..."   No, you could not if you truly had a partner. At that point your partner was still on the deal. So it had to be refinanced by both of you in some way, even if only one name is on the loan. Which brings us to...

    2. "... to buy a partner out..."  What does it mean you had a partner? What was the specific design of your agreement? There are many ways it could have been structured.

    3. "does he pay captial gains tax on the earnings?" - we know nothing about his participation in the deal and nothing about your buyout. Generally, if he received more money than he invested, he owes taxes. And it is not necessarily capital gains, it could be another type of income.

    4. "I wrote my CPA, but he is out of town for the long weekend."  Why is it so urgent that it required an answer before your CPA returns?




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  • Fulton Abraham Sanchez
    CPA| New Clients Welcome| 50 States · Member since 2016 · 435 posts · 93 votes
    1y

    Hi @Ben Szafran. You’re right to double-check this. Generally, your partner’s payout is treated as a sale of his interest, so he may owe capital gains tax depending on his basis and profit. The refinance itself isn’t taxable for you, but his cash-out could trigger taxes on his side. 

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