Author Topic: help me understand real estate sale taxes  (Read 608 times)

sol

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help me understand real estate sale taxes
« on: May 11, 2019, 08:20:06 PM »
I'm considering selling two rental properties, and am trying to understand what taxes I will owe.  I think I need to hire an accountant.

Both of the properties have accumulated about $40k of depreciation since becoming rentals, and my understanding is that all of that is taxed upon sale at ordinary income tax rates (capped at 25%).  So in theory, if I earned $40k at a W-2 job this year and then sold a house with $40k of depreciation recapture, I would end up paying income taxes on $80k.  If I was filing MFJ, I would get to take the $24k standard deduction and then would pay ordinary income taxes on the remaining $56k in the 10% and 12% tax brackets.  That works out to $1940+$4392 is $6,332 in income taxes.

Property 1 has about $100k in capital gains.  If I'm doing this right, then the LTCG rate is 0% on gains up to ~$79k (again assuming MFJ) so at the very least we'd pay the 15% LTCG rate on the remaining $21k, or an additional $3188 in long term capital gains. 

So when we file taxes next year, we'd owe $6,332 in income taxes due in part to the additional "income" from depreciation recapture, and then we'd also ow the $3,188 in LTCG, for a total tax bill of $9,520 (assuming no other complicating factors like child tax credits, RE excise tax, etc.) 

I know some of you are far smarter about this kind of thing than I am.  Have I totally fucked that up?

Because one obvious consequence of this math is that it seems to make a lot more sense to sell a rental property in a year in which you have no W-2 income, so that you can use the standard deduction to offset the first $24k of depreciation recapture from each property separately.  Another obvious consequence is that it would suck to sell both rental properties in the same tax year, because the tax brackets are progressive for both the depreciation recapture side and the LTCG side.  Doing both in one year would put the majority of my LTCG into the 15% tax bracket, where it would mostly be in the 0% bracket if I sold one house per year.

Some of you are actually CPAs.  Do I need to hire a CPA to work through this math, or am I on the right track by myself?  If I do go hire an accountant, what questions do I need to ask?

Goldielocks

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Re: help me understand real estate sale taxes
« Reply #1 on: May 12, 2019, 12:02:52 AM »
You are definitely hitting all the main points.   Real estate investments are very good for people with higher incomes that claim losses due to the depreciation.... and then sell when they retire and income goes down.

Do you have any capital losses that you can realize or apply to the capital gains this year (carried over from prior year, or sell a losing investment this year to offset)?

You can add your buy / sell transaction costs (commission) to your Actual Cost Basis, to reduce the net increase taxable.

An accountant may find a few other savings, but you hit the big ones correctly.

Ocinfo

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Re: help me understand real estate sale taxes
« Reply #2 on: May 12, 2019, 06:00:20 AM »
Looks more or less correct. I sold a rental in 2018 and my similar estimates were in-line with TurboTax when I filed this year. Would it make sense for you to sell 1 in 2019 and the other in 2020?


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seattlecyclone

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Re: help me understand real estate sale taxes
« Reply #3 on: May 12, 2019, 11:29:24 AM »
Both of the properties have accumulated about $40k of depreciation since becoming rentals, and my understanding is that all of that is taxed upon sale at ordinary income tax rates (capped at 25%).  So in theory, if I earned $40k at a W-2 job this year and then sold a house with $40k of depreciation recapture, I would end up paying income taxes on $80k.  If I was filing MFJ, I would get to take the $24k standard deduction and then would pay ordinary income taxes on the remaining $56k in the 10% and 12% tax brackets.  That works out to $1940+$4392 is $6,332 in income taxes.

Property 1 has about $100k in capital gains.  If I'm doing this right, then the LTCG rate is 0% on gains up to ~$79k (again assuming MFJ) so at the very least we'd pay the 15% LTCG rate on the remaining $21k, or an additional $3188 in long term capital gains.

Not quite. The capital gains tax brackets are based on your total taxable income. You don't get any 0% capital gains at all if your other income pushes you above that $79k limit. In this example you already have an AGI of $80k prior to capital gains, which after your standard deduction would be $56k taxable. That leaves $23k of capital gains that would be taxed at 0%. The rest after this would be taxed at 15%, or roughly $11.5k of capital gains tax.

sol

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Re: help me understand real estate sale taxes
« Reply #4 on: May 13, 2019, 11:26:08 AM »
Not quite. The capital gains tax brackets are based on your total taxable income. You don't get any 0% capital gains at all if your other income pushes you above that $79k limit. In this example you already have an AGI of $80k prior to capital gains, which after your standard deduction would be $56k taxable. That leaves $23k of capital gains that would be taxed at 0%. The rest after this would be taxed at 15%, or roughly $11.5k of capital gains tax.

That's super helpful, thanks. 

Doesn't this tax you on the depreciation recapture twice, though?  Like first I pay ordinary income tax rates on the depreciation recapture, then I pay capital gains on it too if it's over $78,750?

So if for example my wage income were $100k and my depreciation recapture were $40k and my capitgal gains were $100k, suddenly I have $240k of total income for capital gains?  And that $40k of depreciation recapture would first be taxed at 22% as income, and then it would get hit with an additional 15% LTCG because it would push an equivalent amount of capital gains from the 0% to the 15% LTCG bracket?

Because taking a 37% tax penalty on depreciation sucks pretty hard.  That tips the scales on RE profitability but a nontrivial amount.

seattlecyclone

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Re: help me understand real estate sale taxes
« Reply #5 on: May 13, 2019, 02:24:32 PM »
It's all in how you look at it. Yes, there are plenty of situations where a marginal dollar of regular income can push a dollar of capital gain income into a higher bracket, thus making your marginal rate on that dollar be more than your tax bracket would suggest. This is not unique to the depreciation capture situation; there are lots of situations in the tax code that can cause your marginal rate to be quite high.

I'm not sure I would personally look at it that way in this case, as the depreciation recapture goes along with the capital gains. Whether you mentally assign the capital gains tax to the depreciation part of the transaction or the capital gains part, the total cost of that real estate sale is the same either way.

sol

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Re: help me understand real estate sale taxes
« Reply #6 on: May 15, 2019, 12:16:31 PM »
I spent 30 minutes with a local CPA this morning.  She basically told me I don't need to hire her.

The fact that I've already estimated our total tax liability for next year if we sell a rental or don't sell a rental apparently makes me an atypical customer.

She also reiterated a lot of the advice typically given here, including that deleveraging can be an important part of your financial journey once you've retired if it helps you sleep better at night, that paying off your primary mortage at 3.25% is probably a dumb idea, and that your best protection against another 2009-style downturn is not a more conservative asset allocation, but a willingness to go out and get another job.

So, a big thumbs up to all the helpful mustachians out there giving good advice to people like me.  Thanks, y'all.

walkwalkwalk

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Re: help me understand real estate sale taxes
« Reply #7 on: May 15, 2019, 02:09:15 PM »
The fact that I've already estimated our total tax liability for next year if we sell a rental or don't sell a rental apparently makes me an atypical customer.
She's probably afraid you would review the return and give her "review notes" (as we call them in CPA firms). ((Basically telling her what was wrong about the return and what needs fixing)). Also, probably didn't see you as a recurring client (which is really the only way CPAs/tax preparers make any money).

You're both better off without each other. Good luck!