Capital Gains on Partial Sale of Investment Property

[Saltie06]

Hello - I'm considering selling a share of an investment property that I own to a family member in order to pay off the mortgage. How do I figure out my cost basis to determine what the capital gain is assuming I don't get a tax form for the transaction? For example, let's say the house is worth $700k. I sell half, making my gain $350k. Do I take 50% of the original sale price (let's say $450k, so $225k) and then 50% of the improvement amount ($100k, so $50k) when figuring out the basis and capital gain? 

So Net Adjusted Basis would be ($225k original price + $50k improvements - $10k depreciation in this example) = $265k

Capital Gain is $350k sale price - $265k basis - $1k sale costs = $84k? 

Is that right? So I'd be on the hook for the 15% of that $84k? And then I'd just enter all that info in the appropriate screens in TurboTax myself? 

[Critter-3]

Did you actually sell 1/2 the property or take on a partner in the rental ?  I highly recommend you seek local professional assistance to determine all the choices you are allowed and the pros and cons of them all.  Some states may require a partnership return to be filed for the joint rental property.  

And you missed one step in the sale calculation if you really did complete a formal sale when you added his name to the deed.  

Of the $84K of profit  the depreciation of $10K depreciation must be recaptured at your regular tax rate and then the rest gets cap gains treatment.   

[Saltie06]

I haven't sold anything yet. I'm just trying to figure out the hit I would take if I did. To your point though I'm not technically selling half the property, so I would need to look into that. We will definitely get assistance with this to actually go through with anything, but just trying to plan. 

[Mike9241]

so apparently you own 100% and will be selling a fraction to a family member,   Turbotax can't easily handle a fractional sale of a property. you would need to manually split the property into 2 parts the fraction you are selling and the fraction you are keeping. you would need to enter original costs and the depreciation taken on the fraction you are selling.  you will be subject to section 1250 recapture up to the amount of the gain on the fraction you are selling. only the gain in excess of the 1250 recapture would be capital gain. (in your example 10K of 1250 gain - tax rate up to 25% - $74K of capital gain - tax rate depends on your total tax situation - some ould be 0%. to complicate matters you may now be required to file an annual partnership return with the family member and of course the need to incur costs to add the family member to the title. 

A joint undertaking merely to share expenses isn't a partnership. Mere co-ownership of property that is maintained and leased or rented isn't a partnership. However, if the co-owners provide services to the tenants, a partnership exists.

[Carl]

Here's my two cents, and keep in mind it's only one perspective of a few.

For starters, TurboTax is a bear when it comes to fractional sales of real estate. It can be done, but it requires a lot of manipulation and manual math on your part, thus greatly increasing the possibility of human error resulting in an audit. So in my opinion professional help is not an option - it's a must.

Since this involves rental property, this sounds to me more like the establishment of a partnership where you have a family member "buying into" your rental business. That opens an entirely new can-o-worms on the tax front, as a partnership between two unmarried individuals not filing a joint tax return together generally calls for a completely separate 1065 partnership return to be filed. (Although with rental real estate, that can sometimes be avoided by reporting your percentage of ownership on the SCH E if your state and local laws don't prohibit it.)

Because of all the different "points of view" one can take on this, I would suggest you seek getting educated on your options not only by a local tax professional (especially if your state taxes personal income), but also by a real estate professional. Generally though, I wouldn't expect a real estate professional to be that knowledgeable on the tax front.  But if the family member will be taking out a mortgage for their half, it will definitely affect you (and not in a positive way) should that family member default on the mortgage.

As an example, if they default on the loan, the lender may not foreclose on half the property - they're foreclosing the whole enchilada.

[Anonymous_]

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@Carl wrote:

Because of all the different "points of view" one can take on this.....

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As @Mike9241 indicated in his post, mere co-ownership of property that is maintained, kept in repair, and rented or leased does not constitute a separate entity for federal tax purposes. 

The foregoing is not a "point of view", it is a Federal Regulation (Section 301.7701-1(a)(2)).

[Carl]

does not constitute a separate entity for federal tax purposes.

True. But that's why I stressed "one point of view". In some cases it may actually make more sense and/or be more beneficial to treat it as a partnership. That's yet another reason to seek professional help so one can get educated on the pros and cons of all available possibilities.

[Anonymous_]

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@Carl wrote:

.....that's why I stressed "one point of view". In some cases it may actually make more sense and/or be more beneficial to treat it as a partnership. 

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I agree, except you wrote, "Since this involves rental property, this sounds to me more like the establishment of a partnership" when it is clear from the regulation I cited that such would not be the case (unless the parties actually decided otherwise).