Pls help to figure out how tax from sale is calculated

[Mary Jay]

Hi guys,

So Ive been thinking to sell one of my rentals. It has not much of equity in it because I took out a private loan (second mortgage from my ex boyfriend. At the time I took the loan out he was my boyfriend, then we split). I want to sell it, and I dont want to do a 1031 exchange on it. But I am trying to figure out how much will the tax be. If its too much, I might need to do a 1031 exchange...

For the simplicity of calculations, lets pretend I dont have to pay any real estate commission....

1) So I purchased it for 230K in the end of 2011, then refinanced it during Covid (in 2020) and pulled some equity from it, and owe now 250k on it... 

Then I had to take a second loan from my then boyfriend a year ago, and my loan to my ex is 300k, which Ive been paying but did not pay off much...

So total I owe on the house is 550k ( 250K to the bank+300K to my ex boyfriend)

The house is worth 700k...It was always a rental.

If I sell it now, lets say I sell it for 700k... How will the tax that I owe to the IRS calculated?

will I be paying taxes on:

1) 700k (sell price) - 230k (what I purchased the house for in 2011)= 470K, so my tax burden will be 235k?

or

2) 700k (sell price) - 550K (250k 1st lien that  I owe to the bank + 2nd lien that I owe to my ex 300k)=150K of the profit that I make will be taxed. 75k of tax I will have to pay to the IRS...

Which scenario is correct?

Thank you so much!!!  

[Michael Plaks]

Quote from @Dave Foster:

@Mary Jay , You are probably looking at tax on a lot more than $235K. The profit calculations would be your adjusted cost basis (purchase price, plus capital improvements, minus depreciation), subtracted from the net sale of the property (sales price minus closing costs and commissions), like others mentioned above.

It doesn’t matter how much you owe on your loans. So, you’ll be taxed on the gain between your purchase price and your sale price, not the amount of cash you walk away with. You're looking at a bunch of depreciation recapture (all of the depreciation taken since 2011 - depreciation could be well over 100K by itself), and you pay 25% on that. So, it would probably be worth your while to do a 1031 exchange.

Feels weird to disagree with my good friend, but this time Dave is incorrect.

You do not pay 25% on the depreciation recapture. You pay no more than 25% but possibly a lot less. Which is why I keep saying: it is all case-by-case.