Capital Gains

[lal2611]

When do I pay capital gains if I sell a rental property as "owner financed". The terms are to pay interest only on a note of $475,000 at a rate of 5% for 10 years and then make a balloon payment. The purchase price of the home would be $500,000 with a down payment of $25,000.

[Mike9241]

you can sell using the installment sale method form 6252. your gain is taxed in proportion to the principal proceeds received each year. interest as collected each year is separately reported. it is crucial that at least one payment be received in the year after the year of sale.

that $25K will first be applied to section 1250 recapture with any excess applied to capital gain

so year of down payment taxable gain = gain * 25000 /500000 (5% of gain) with 95% of gain recognized in the year the balloon payment is received

this is purely elective. in some case a taxpayer may want to opt out if installment sale reporting 

[Rick19744]

Just to be clear.

If a sale qualifies for the installment sale, then the provisions of the installment sale are mandatory.

If a taxpayer does not want to use the installment sale, for whatever reason, the taxpayer must make an election to elect out of the installment sale provisions.

[lal2611]

Thanks for the reply! Can you tell me more about "if a sale qualifies"? How do I know if my sale qualifies?

[lal2611]

Thanks for the reply! Is depreciation recapture calculated by taking the purchase price divided by 27.5? If so, our purchase price ($235K)/27.5 is $8,545. Do I then multiply that by the # of years we've owned? Also, if we didn't take $8,545/year as depreciation on our taxes but took less, does that change anything?

[Mike9241]

except for publicly traded securities (inventory has special rules) any sale qualifies as along as at least one payment is received in the year after the sale closes even if 100% of the sales price. 

[Mike9241]

you may have several tax issues. have you been depreciating the value of the land?  land is not depreciable. if you took less depreciation then the tax laws allow, they provide your recapture amount is based on the depreciation you should have taken.  too much taken and you recapture is based on that amount. also, there are tax rules for how much depreciation you can take in the first year the property goes to rental and similar rules for the year of sale.  If you been doing it wrong I suggest you consult a tax pro 

[Rick19744]

Upon the sale of real property where depreciation has been taken (or should have been taken), the seller will have what is called unrecaptured Section 1250 depreciation.

This is essentially all depreciation taken (or should have been taken).

The seller will compute the gain on the sale.  The seller will then have to recharacterize some of the gain.  This is the unrecaptured Section 1250 component.  This is a recharacterization only.  The portion of the gain that is recharacterized as Section 1250 will have a maximum of 25% tax rate.

A simple example:

Overall gain is $125,000

Unrecaptured Section 1250 is $75,000

The seller will have unrecaptured Section 1250 gain of the $75,000 taxed at a maximum of 25%

The seller will then have capital gain of $50,000; total gain $125,000

I agree meeting with a tax professional in situations such as this may be helpful.