Author Topic: Need advice on how to avoid/reduce tax to sale investment property  (Read 1877 times)

backandforth

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Need advice on how to avoid/reduce tax to sale investment property
« on: September 18, 2017, 02:13:50 PM »
Long time landlord on paper but not in essence... so please bear with me if I sound na´ve and deserve a face punch or two..

So here is the deal. My husband "bought" a house before we got married, as an investment property. Actually it was my MIL putting down the down payment, but DH applied for the mortgage because his credit was much better and got great interest rate. It could have been a risky move I know, but it was water under the bridge and MIL has been living up to her promise.

On a day to day basis, the house has been rented to MIL to run a small business in, she paid for all the upkeep and mortgage/insurance/etc, and the "rent" is to cover all that expense so it's pretty much break even each year, on paper. Although we don't really get or spend anything at all. Since the mortgage is in DH's name, we file for it under our tax return, and we deduct the interest to lower tax bills.

Now it has come to a time that MIL is considering downshift and retire over the next 2-3 years, and selling the house has become a real possibility. My question is, over the years as an investment property, the house has been depreciated on a schedule that lower the tax base, and if we sell at market value there will be some decent gain that we have to pay lot of tax on.

Is there any way we can reduce that tax? I am thinking, for example, maybe MIL sell her primary residence if she can let that go, and live in the investment property, and we claim it as a second home for 2 years, then we sell. Will that reset the cost base? Is that legal?

What if MIL is too attached to her current house and don't want to move? What do we do then? DH and I have over the years grown into a relatively high income bracket and forking out all that tax out at current level will be painful.. especially we never really see a dime come in, although we did reap the benefit on our tax returns.

The house is a single family home, I guess it can be rented out but barely breakeven... and we will run the risk of actually losing money, and it's 2 hours from our house, if MIL retires for good, nobody is going to take care of it, so we probably have to sell it. The good news is that we still have a couple of years to go before pulling the trigger, and any advice for tax reduction maneuver is much appreciated!

Cwadda

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Re: Need advice on how to avoid/reduce tax to sale investment property
« Reply #1 on: September 18, 2017, 02:22:25 PM »
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some decent gain
Could you quantify this?

backandforth

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Re: Need advice on how to avoid/reduce tax to sale investment property
« Reply #2 on: September 18, 2017, 03:02:48 PM »
Hi Cwadda, so on the gains. The cost basis for the house (not land) is about 200K, it was on a 30 year mortgage, and we are half way through the depreciation on the house. If we are to sell it today after the realtor cost etc (budgeted 8% total of selling at the fair market price). I think we will have about 95K in taxable gains. So at 15%, it's about 15K. Ouch!

sokoloff

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Re: Need advice on how to avoid/reduce tax to sale investment property
« Reply #3 on: September 18, 2017, 03:12:51 PM »
As I understand it, depreciation recapture is at 25%, not ordinary income rates.

tralfamadorian

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Re: Need advice on how to avoid/reduce tax to sale investment property
« Reply #4 on: September 18, 2017, 08:08:40 PM »
As I understand it, depreciation recapture is at 25%, not ordinary income rates.

Yep, it's 25% so the tax would be $23.75k.  It cannot be reducing by changing the property to a vacation property.  The only way to reset the cost basis is to pass away; the heirs would inherit the property at a stepped up basis.  Providing your demise is not imminent, your other option is a 1031 exchange; the depreciation would be carried forward to the new property. 

CareCPA

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Re: Need advice on how to avoid/reduce tax to sale investment property
« Reply #5 on: September 18, 2017, 09:37:18 PM »
As stated, the 2 year-rule of living there would not wipe out the tax on the gains in the past since it was already used for business.

In addition, you may not technically have been able to take the losses over the years that you have taken. For residential properties, there are special rules on renting to family members. I'm not 100% sure off the top of my head if it applies to commercial use, but you may want to look into it.

backandforth

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Re: Need advice on how to avoid/reduce tax to sale investment property
« Reply #6 on: September 19, 2017, 08:16:26 AM »
Thanks All! So it looks like there is pretty much no way out of it?

What do you guys plan to do with your rental properties? keep it forever and pass it on to your children? or just pay the tax at some point?

tralfamadorian

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Re: Need advice on how to avoid/reduce tax to sale investment property
« Reply #7 on: September 19, 2017, 10:18:41 AM »
Personally, I plan on keeping the cash cows forever and eventually 1031ing the others into lifestyle properties.  Unless something unforeseen happens, I don't anticipate ever selling them in a taxable event. 

backandforth

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Re: Need advice on how to avoid/reduce tax to sale investment property
« Reply #8 on: September 19, 2017, 11:05:38 AM »
Tralfamadorian, would you mind elaborating what do you mean by "life style" properties? Does that mean you would one day convert it as a second home for yourself or that's something else entirely?

tralfamadorian

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Re: Need advice on how to avoid/reduce tax to sale investment property
« Reply #9 on: September 19, 2017, 12:50:49 PM »
...you would one day convert it as a second home for yourself...

Exactly.  US property can be exchanged for property in the US and US territories.  So you can 1031 your desirable but time consuming student rentals into a condo in Aspen or a cottage in Nantucket but not an apartment in Paris.  The new property would need to be used as an investment property for a period of time- some say one year, some say two- before it could have more than 14 personal use days/year. 

cchrissyy

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Re: Need advice on how to avoid/reduce tax to sale investment property
« Reply #10 on: September 19, 2017, 01:00:17 PM »
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Since the mortgage is in DH's name, we file for it under our tax return, and we deduct the interest to lower tax bills.

hang on, this part sounds like you are using the personal mortgage interest deduction, and not like you are accounting for the rental expense on the schedule E. Better check this. Are you sure the income and depreciation are even showing on your taxes?  Don't answer here if you don't want to. But, if a person was doing the taxes properly the mortgage interest wouldn't be itemized, it would be an expense on the schedule E, and what you wrote above makes me question that.

backandforth

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Re: Need advice on how to avoid/reduce tax to sale investment property
« Reply #11 on: September 26, 2017, 12:30:06 PM »
Thanks all, for your input. I am scheduled to talk to our accountant next week. He is an experienced one and have done our tax for years, hopefully we can sort it out soon.