topic Pre-paid principal on investment property in Deductions & credits

Pre-paid principal on investment property

Anonymous — Sun, 15 Dec 2024 20:19:39 GMT

Hi, I'm trying to figure out the tax basis for a rental property I'm selling. Let's say I bought the property for $500 with $400 mortgage and $100 equity. For simplicity, let's say that the loan is now down to $100 because I prepaid $300 and the net proceeds, if the sale price is $600, are $600-100=500. Had I not prepaid the mortgage, the net proceeds would be $600-400=200. So the question is, how do I factor the $300 I prepaid in the tax basis and does it make sense I take out a loan of $300 just before selling the property to recover the principal prepaid?

Re: Pre-paid principal on investment property

pk — Sun, 15 Dec 2024 22:22:57 GMT

@Anonymous , the amount of mortgage principal owed has NO place in the gain/loss computation ( for tax purposes )

In general

(a) Basis in the property = Acquisition COST + plus cost of any improvements during the holding period.

(b) Depreciation Basis = Acquisition Cost LESS Land / non-depreciable Cost. It is the cost of the improvements. It is often 2/3 or 1/2 of the purchase price, sometimes allocated in multi-story buildings with many condos. Note annual depreciation is based on Depreciation Basis and the Useful Life of the asset ( residential property in the US has a life of 27.5 years

(d) Sales Expenses = Allowable / customary and necessary expenses associated with disposition ( such as sale commission, Transfer tax, title work, immediate repair work etc. expressly for the sale etc. etc. )

(e) At disposition / sale , the cost basis = Original Basis [ item (a) above] LESS Accumulated Depreciation [ item (c) above ].

(f ) Taxable Gain/Loss = Sales Proceeds ( i.e. Sales Price LESS Sales Expenses ) LESS COST BASIS

Note that only that portion of the gain above/beyond Accumulated depreciation is treated as Capital gain the rest is ordinary gain.

(g) Actual amount received by you before taxes is Sales Price LESS Loan Balance. However this has nothing to do with the taxable gain/loss computation.

Is there more I can do for you ?

Re: Pre-paid principal on investment property

Opus 17 — Mon, 16 Dec 2024 15:10:37 GMT

Loans have nothing to do with cost basis. Your starting basis is $500. Then, you can include the cost of permanent improvements, and you must subtract depreciation you claimed or could have claimed.

Let's go way from a rental and look at a simple investment. You buy for $500 and sell for $1000. You have a $500 capital gain. Suppose you paid all cash, and get $1000 of proceeds. Your gain is $500. Suppose you paid $100 down and $400 loan, therefore you only get $500 proceeds after selling. Your gain is still $500. Suppose you refinanced (borrowed) an additional $500, so your loan was $900. You still have a capital gains of $500, the difference is just that you took some of the proceeds early as part of the loan.