How to Tax plan for Sale of Rental Property, held for 18 years

[Fooz]

Hi,  we are married, seniors, filing jointly and project having a 1040 adjusted gross income of  $30K and plan to  take  the standard deduction.  We are selling  a rental home and project our long term capital gains (sale price minus expense of purchase 18 yrs ago plus sales expenses now) to be about $90K.

If we take all of that profit now to pay off our current mortgage, what tax impact should we plan for from adding that $90K to our adjusted gross income this year?

[tagteam]

What you do with the proceeds from the sale, such as pay off an existing mortgage, will not have any impact on your tax liability from the sale.

However, if you did a 1031 (like-kind) exchange, you would potentially be able to defer any gain.

See https://www.irs.gov/businesses/small-businesses-self-employed/like-kind-exchanges-real-estate-tax-ti...

Regardless, you did not state whether the $90,000 gain included any depreciation recapture. You were (are) required to take depreciation deductions during the time the property was held for rental use and, whether or not you did so, the depreciation deductions you could have taken must be used to reduce your basis. Upon a sale, accumulated depreciation is taxed at your ordinary income tax rate up to a maximum of 25%.

If you did not take depreciation deductions, you will have to contact a tax professional.

[Carl]

Really, the only thing I see here to "plan" for is to pay taxes on any realized gain, as well as recaptured depreciation. Typically, if you put 20% of your gain aside for taxes, then you should be fine come tax filing time. If your state also taxes the gain then you should put aside an  additional percentage for state taxes.

Unfortunately, a 1031 exchange will not allow you to pay off your existing mortgage on your residence. That also only delays your tax liability. It doesn't eliminate it.

[tagteam]

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@Carl wrote:

Unfortunately, a 1031 exchange will not allow you to pay off your existing mortgage on your residence. That also only delays your tax liability. It doesn't eliminate it.

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Exactly; the proceeds have to be used to purchase replacement property.

However, holding the replacement property has the potential to eliminate tax liability on the transaction if the property is held until the owner's death (provided the stepped up basis is not eliminated by Congress).

[Mike9241]

if you are considering doing a 1031 exchange, consult with a real estate lawyer that does these. there are many rules that must be complied with, besides the one of not being able to touch the money from the sale - doing so would make part or all of the gain taxable. make one mistake and the sale becomes fully taxable while all the money is tied up in the replacement property.

[Fooz]

Thanks for your insights.  We aren't interested in doing the like exchange to avoid taxes on the rental property.  As retirees, our outlook is no longer one of distant rewards, hence the sale of the rental which has over the years been productive.   We have been depreciating the property over its lifespan and for this question, I took the initial cost of purchase plus the cost of sale, less the sales price.  Thanks Again!

[tagteam]

Did you factor your accumulated depreciation deductions into your equation?

You need to subtract the total amount of depreciation deductions taken from your cost basis.

[Fooz]

Thanks Carl for your answer,   It sounds like the smart thing would be to hold back 20% of the $90K long term capital gain (( $175K sales price less ($35K sales expenses  + $50K initial purchase Price) = $90K)

I'm starting to wonder from the answers here if I need to add 18 years worth of depreciation ($19K) back onto the $90K as indicated above.  In that case, should the plan be to have 20% of $109K set aside for possible taxes?

[tagteam · Accepted solution]

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@Fooz wrote:

...$175K sales price less ($35K sales expenses  + $50K initial purchase Price) = $90K...

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$175,000 less selling expenses of $35,000 equals $140,000.

$140,000 less your adjusted basis of $31,000 ($50,000 purchase price less $19,000 accumulated depreciation) equals:

$109,000 gain (with $19,000 being taxed at your marginal tax rate up to a maximum of 25%).

$

[Fooz]

Thanks for this great answer.  Everyone has really helped out.  We need to dig deeper into our pockets than previously hoped but we are forewarned with the great advice everyone, Kudos!!