I am getting ready to sell a rental property and wanted to talk to someone to understand exactly what I will have to pay capital gains on and what is the approximate percentage that those gains would be.
I also need to understand how the depreciation recapture works and what they might look like.
Round numbers to make it easy:
Original purchase price 300k
Sales Price 500k
Equity today 250k
Depreciated for 6 years
I have talked the 1031 exchange process but I wanted to understand what tax implications would be if I didn’t go 1031 so I would have a little more time to look into different options before I move it back into Real Estate.
Of course I highly recommend discussing this with your personal accountant who will have a better view of your full situation.
Using $300K for the purchase price plus purchase closing costs and assuming no fixup prior to being rent ready (which adds to your basis) then $300K is your initial basis. Using the typical 80/20 split for improvements/land gives a depreciable amount of $240K. Six years of depreciation would be 6/27.5*$240K of about $52K. So your basis is now $188K. Lets assume 8% closing costs on the sale, so your net is $460K. That means your total gain is $460K-$188K=$272K. You'll pay tax on unrecaptured depreciation on the first $52K of gain. That's your ordinary income rate, though capped at 25% (I think, might have changed under the new law.) The remaining gain of $220K is capital gain and taxed at 15% (again, assuming nothing changed in the new law.) The outstanding loan amount has no effect on the taxes. So, assuming your marginal tax rate is over 25% (which may be a bad assumption with the new tax brackets) you would pay $13K for the unrecaptured depreciation tax and $33K for the capital gains for a total of $46K.
Its possible the Obamacare tax on investments or AMT might come into play and increase this. That, along with the rate for the unrecaptured depreciation tax is why you should work with your personal accountant. If you sell now you'll need to make quarterly payments, so you need to be sure those are in the right ball park to avoid penalties.
@Jon Holdman don't forget about the $60k you allocated to land in your example. Although nondepreciable that still is a part of basis and reduces the gain.
Doh, I messed that up. The basis at the time of sale would be $300K - $52K, not $240K - $52K. So only $160K capital gains and only $24K in capital gains tax. Thanks for catching my error @Logan Allec .