Tax Question

[New Guy]

My father owns several rental properties and I recently recommended that he sell one particular property. He was receptive to the idea but was worried about the tax implications he would have. He owns the property outright and actually used the home as a primary residence for about 15 years. However, over the last 15+ years he has used it as a rental property.

My question is will he have to pay capital gains taxes on the appreciation? Is there any way to avoid taxes without reinvesting the money back into real estate during the next few years?

I estimate that his gain will be about $400,000 if he sells.

Thanks.

[SD Realtor]

My first comment is that I am a Realtor so my answers should be taken with a grain of salt. For tax implications ALWAYS talk to a CPA or tax professional…

Since I like to chat here goes.

1 – I am assuming he is not going to sell the home, and then defer the taxes by purchasing a like property. This is known as a 1031 exchange.

2 – Make sure you calculate his tax liability correctly. If he indeed will have a 400k capital gain MAKE SURE you recapture his depreciation expense. Recapture is calculated as follows, for every year he took a depreciation expense, he will need to add all those deductions back to his cost basis.

Example –

Lets say I buy a home for 300k and rent it out for 10 years. Each year I rent it out I also claim a 3k depreciation expense. Now 10 years later I sell it for 350k. So my capital gains expense is 50k PLUS 30k. The 30k is 10 years multiplied by 3k per year. So my total tax liability is for 80k.

3 – Even IF YOU DID NOT take a depreciation expense each year you owned the property, you still may be liable for depreciation recapture. That is the first question I would ask my tax guy if I were you. However, any owner of rental property should be taking that depreciation expense.

Okay if you do not invest the money back into a like property there are a few alternatives.

1 – If you are carrying any previous capital losses from say stock losses or something of that nature, then you could use those to offset your gains. I had and still have very substantial losses from previous market forays and I had a sale of rental property that had great appreciation. Those gains were totally absorbed by my mountain of capital loss. (OBVIOUSLY DONT TAKE INVESTMENT ADVICE FROM ME)

2 – There are Private Annuity Trusts. I am not to knowledgeable of these vehicles but from what I know they are kind of cool for defering capital gains on highly depreciated property.

– first you put your property in the name of the private annuity trust.

– when you sell the property the proceeds go into the trust.

– while the assets are in the trust they can be reinvested into other investment vehicles, and they can be different then real estate.

– Now your father would receive annual payments from the trust. The amount of those payments is what i do not understand. Losely they would be based on mortality tables. Each time your father receives a payment he would have a tax liability but since each annual payment is much less then the 40k the tax is spread out.

Note PATS do not make the tax go away, however they do defer the tax and essentially spread it out over a long period of time. Meanwhile all the money in the trust can be reinvested and earning a return.

Double note, I only know a little bit about PATs so hopefully someone will add to this post and correct me where I am wrong.

[Author]

Posts