Author Topic: Tax question on sale of rental property  (Read 1488 times)

Hamster

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Tax question on sale of rental property
« on: May 05, 2014, 10:47:41 AM »
A tenant has offered to purchase a rental property of ours at a fair price. It's a loss for us, but we did make money on the rental income, and it will allow us to move capital to something with higher returns.

My wife is a real estate agent, and will handle the whole deal, so we aren't paying out any commissions. Our question is whether we should pay her a commission from our proceeds and what it will mean for our taxes. Some of her fellow agents say it is better to pay yourself a commission than not pay yourself a commission when you sell your own properties. Doing the math, I don't think that is correct - at least not in our scenario. I would love input as to whether I'm thinking through this correctly.

Purchase price  (2007)    $420k
Prior years' depreciation   $70k
Adjusted basis                $350k

Sale price                        $400k
Minus transaction costs    $10k
Adjusted sale price          $390k

$390k minus $350k yieds Sec 1250 gains of $40k on the sale, taxed at 25%.

That's a $10k income tax bill on the sale assuming we don't pay any commission.

On the other hand, we could legally pay her a 10% commission ($40k) from the proceeds. Her managing broker lets her keep the full amount.  This would convert the $40k from SEc 1250 gains into self-employment income.

We will likely be at a 28% marginal tax rate. Add in self-employment tax at 15.3% (Medicare and SS) and that's a whopping 43% tax on her commissions.

$40k commission * 43% = $17,200 taxes due.
 
If we put the max of $10k (25% of her commission) (or $10k) into her solo 401(k)* that will reduce her total taxes due on the deal to about $13k. And, the $10k that we put into the 401k would eventually be subject to taxation when we take it out.

So, it looks like taking no commission, and just paying the sec 1250 gains is the best option for us by a few thousand dollars today, and more tax savings in the future .

Is there something that I am missing? Or some other reason that other agents would tell her it's better to take a commission than pay on the gains?


*Her allowed contribution is $17,500 plus 25% of earnings, but we assume that her other commissions will have already used up that first $17.5k
« Last Edit: May 05, 2014, 11:42:21 AM by Hamster »

Fishingmn

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Re: Tax question on sale of rental property
« Reply #1 on: May 05, 2014, 10:50:40 AM »
You would need to compare that to what your tax rate would be on the income (state/fed).

You should also consider whether her broker is going to take a split if you claim it as commission.

Hamster

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Re: Tax question on sale of rental property
« Reply #2 on: May 05, 2014, 11:43:13 AM »
You would need to compare that to what your tax rate would be on the income (state/fed).

You should also consider whether her broker is going to take a split if you claim it as commission.

oops. I accidentally posted a fraction of the post. The whole thing is now posted above.

Fishingmn

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Re: Tax question on sale of rental property
« Reply #3 on: May 06, 2014, 07:02:16 AM »
A couple other things that might help the "commission" side (but I don't think enough so to matter).

You do pay both sides of FICA as a real estate agent but you do get a credit for 1/2 of it back on the 1040 which does lessen the tax hit somewhat.

Also, by paying into FICA it's possible that this will help when it comes to calculating your SS payout but I have no way to calculate what that might be. There is a SS Benefit Calculator that you maybe could model this.