About to sell a rental house and take cap gains hit

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beagle1
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Joined: Sat Oct 02, 2010 3:09 pm

About to sell a rental house and take cap gains hit

Post by beagle1 »

We've finally decided to get out of long-distance rental real estate and sell an out-of-state property. We have one other rental and we're eventually looking to wind down and not be landlords anymore.

I originally purchased the out-of-state property for $100,000 and it is now worth between 650k and 700k. I've taken some depreciation deductions on tax returns which I know will lead to recapture. The house is located out of state and we do not want to relocate to live in it for two years.

Using the SmartAsset calculator, the effective cap gains tax rate will be 10.6% since California (our home state) treats cap gains as regular income; the federal effective rate will be 20.3% according to the calculator.

I've considered 1031 exchanges but just am not optimistic of finding something worth purchasing. The only reason we'd do a 1031 is to upgrade our current house - rent the 1031 for two years and then move in. But our area is very high demand and properties we'd want to live in are significantly more expensive than the out of state house we're selling.

I've also looked at more exotic instruments like DSTs and not really sure about going that route, though it is an option that would buy us time. I'm not wild about the option though from my preliminary research.

My questions:

1) Is there anything else I should be considering? Or this is just the cost of selling a rental property when you no longer want to continue investing in rental real estate?

2) Also considering what to do with the proceeds since we do have an eye out for another property for ourselves. I know HYSA is normally the best action when money is needed in the near term, but any alternatives that are generally conservative but with more yield? I'd hate to park 400K in a couple of HYSA accounts. I think I know the answer to this but am hoping I'm wrong.

Thanks in advance for any insights.
fyre4ce
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Re: About to sell a rental house and take cap gains hit

Post by fyre4ce »

It's a common misconception that you can move into a rental property for two years as a primary residence, and then exclude a $250/500k capital gain on the property. There are two separate calculations: the exclusion you're eligible for, and then the amount of gain eligible for exclusion.

The first calculation, the maximum exclusion you're eligible for, is up to $250k single or $500k married if you've lived in and owned the property for at least 2 out of the last 5 years. If you've lived in/owned for less than 2 years then this number can be reduced.

The second calculation is the amount of your actual gain that is eligible for exclusion. First, any depreciation you've taken gets subtracted and is not eligible for exclusion. Next, the remaining gain gets apportioned between days of qualified use (primary residence) and non-qualified use (not primary residence, eg. rental use). Only non-qualified use after the last day it was your primary residence and within the last 5 years is excluded from this calculation. That's why you can rent a house for up to 3 years after you move out and still get the full exclusion on your full gain. But if the order is reversed (first rental, then primary residence) then only a percentage of your gain can be excluded. In your case, this will probably reduce your exclusion. But, for very large gains, a small percentage of primary residence use could be enough to get your maximum exclusion.
abracadabra11
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Re: About to sell a rental house and take cap gains hit

Post by abracadabra11 »

Any carryover losses from tax loss harvesting?
Any disallowed carryover losses from the rental property in previous years?

Those two items saved us ~$20k in taxes when we sold our rental property.
secondcor521
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Re: About to sell a rental house and take cap gains hit

Post by secondcor521 »

1. Take a look at Pub 523 to see what, if anything, can be added to your basis. Generally speaking, the cost of capital improvements such as new roofs, remodeled kitchens and baths, and upgraded HVAC systems can be added to basis. Some selling costs can also be added to basis. Repairs and maintenance generally cannot be added to basis.

2. It sounds like you know this, but anything that has higher yield either loses liquidity (CDs) or risks principal. Some people are willing to accept those risks, most people are not. Up to you to decide how you define "best" for your situation.
brian91480
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Re: About to sell a rental house and take cap gains hit

Post by brian91480 »

Renting a property has been very good to me for the past 10 years. But the government really sticks it to you when it's time to sell.

I think you're going to have to suck it up and pay the taxes. First world problem... you're paying taxes because you made a killing. 👍

--- Brian
Topic Author
beagle1
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Re: About to sell a rental house and take cap gains hit

Post by beagle1 »

Duplicate post
Last edited by beagle1 on Thu Jan 27, 2022 10:54 am, edited 1 time in total.
Topic Author
beagle1
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Re: About to sell a rental house and take cap gains hit

Post by beagle1 »

Thanks I'll check. I know I've added the remodel to the basis, but not the roof.
secondcor521 wrote: Thu Jan 27, 2022 7:35 am 1. Take a look at Pub 523 to see what, if anything, can be added to your basis. Generally speaking, the cost of capital improvements such as new roofs, remodeled kitchens and baths, and upgraded HVAC systems can be added to basis. Some selling costs can also be added to basis. Repairs and maintenance generally cannot be added to basis.

2. It sounds like you know this, but anything that has higher yield either loses liquidity (CDs) or risks principal. Some people are willing to accept those risks, most people are not. Up to you to decide how you define "best" for your situation.
Topic Author
beagle1
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Re: About to sell a rental house and take cap gains hit

Post by beagle1 »

Brian, totally agree. It's just a bit of a shock when you run the numbers ahead of the sale. But what you say sounds about right
brian91480 wrote: Thu Jan 27, 2022 7:43 am Renting a property has been very good to me for the past 10 years. But the government really sticks it to you when it's time to sell.

I think you're going to have to suck it up and pay the taxes. First world problem... you're paying taxes because you made a killing. 👍

--- Brian
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Sandtrap
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Re: About to sell a rental house and take cap gains hit

Post by Sandtrap »

Can you sell all of your properties that you have in mind and 1031 exchange to something in the area you want?

j :D
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Topic Author
beagle1
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Re: About to sell a rental house and take cap gains hit

Post by beagle1 »

Inventory is so low in our area and people are paying 20, percent 9ver asking price for decent properties. That's why I'm not particularly optimistic. And not sure I want to continue to be a landlord.
Sandtrap wrote: Thu Jan 27, 2022 11:01 am Can you sell all of your properties that you have in mind and 1031 exchange to something in the area you want?

j :D
fyre4ce
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Re: About to sell a rental house and take cap gains hit

Post by fyre4ce »

If I gave you two choices:
  1. I give you $500,000 and also give the government $100,000, or
  2. I give you and the government nothing
Which would you pick? Choosing the second option because the government gets less money doesn't make much sense to me.

I'm being a bit snarky, but the point is still valid I think. You made an investment. It paid off very well (7x growth, not accounting for any leverage). You should be very happy that you have this gain. I'm totally in favor of working within the limits of the tax code to reduce your taxes as much as legal. But in this case, if you don't want to move into property and try to exclude part of the gain from it being your primary residence. You don't want to do a 1031 exchange. Both of those are fine. Your remaining option is to pocket the roughly $500,000 after-tax gain and go on with your life. Many people on this board have an aversion to paying taxes, which can he healthy in small doses but can be counter-productive when taken too far.
WildBill
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Re: About to sell a rental house and take cap gains hit

Post by WildBill »

Howdy

You are going to make a killing on an investment and will have to pay the capital gains tax.

Grit your teeth and file it under “Problems of Prosperity”

Sometimes you just have to pay taxes

W B
"Through chances various, through all vicissitudes, we make our way." Virgil, The Aeneid
Topic Author
beagle1
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Re: About to sell a rental house and take cap gains hit

Post by beagle1 »

I don't disagree with anything you said and I have no complaints. It's more a matter of making sure that there's nothing I'm missing or that I need to be thinking about going forward.

I'm not surprised by the tax bill that will come due, but just penciling things out does put it into perspective and give me pause.
fyre4ce wrote: Thu Jan 27, 2022 1:07 pm If I gave you two choices:
  1. I give you $500,000 and also give the government $100,000, or
  2. I give you and the government nothing
Which would you pick? Choosing the second option because the government gets less money doesn't make much sense to me.

I'm being a bit snarky, but the point is still valid I think. You made an investment. It paid off very well (7x growth, not accounting for any leverage). You should be very happy that you have this gain. I'm totally in favor of working within the limits of the tax code to reduce your taxes as much as legal. But in this case, if you don't want to move into property and try to exclude part of the gain from it being your primary residence. You don't want to do a 1031 exchange. Both of those are fine. Your remaining option is to pocket the roughly $500,000 after-tax gain and go on with your life. Many people on this board have an aversion to paying taxes, which can he healthy in small doses but can be counter-productive when taken too far.
Topic Author
beagle1
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Re: About to sell a rental house and take cap gains hit

Post by beagle1 »

Agree! Just making sure I haven't missed anything in planning for this or moving forward.
WildBill wrote: Thu Jan 27, 2022 1:37 pm Howdy

You are going to make a killing on an investment and will have to pay the capital gains tax.

Grit your teeth and file it under “Problems of Prosperity”

Sometimes you just have to pay taxes

W B
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goingup
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Re: About to sell a rental house and take cap gains hit

Post by goingup »

I know not everyone wants to do it this way, but here’s how we are handling our highly appreciated CA rental. (Bought for $180K, would sell for $1m +.)

We moved back in and remodeled. So added a lot to basis. We’ll live here for several years to get $500k fed tax exemption. We’ll hopefully have $50-$100k in harvested losses from stock/bond funds. And we’re early retired so have modest taxable income.

That’s the plan, though we’re liking this remodeled home pretty well and may just stay put. :happy
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Nate79
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Re: About to sell a rental house and take cap gains hit

Post by Nate79 »

goingup wrote: Thu Jan 27, 2022 5:48 pm I know not everyone wants to do it this way, but here’s how we are handling our highly appreciated CA rental. (Bought for $180K, would sell for $1m +.)

We moved back in and remodeled. So added a lot to basis. We’ll live here for several years to get $500k fed tax exemption. We’ll hopefully have $50-$100k in harvested losses from stock/bond funds. And we’re early retired so have modest taxable income.

That’s the plan, though we’re liking this remodeled home pretty well and may just stay put. :happy
I hope you read fyre4ce's post above on this topic.
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goingup
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Re: About to sell a rental house and take cap gains hit

Post by goingup »

Nate79 wrote: Thu Jan 27, 2022 5:54 pm
goingup wrote: Thu Jan 27, 2022 5:48 pm I know not everyone wants to do it this way, but here’s how we are handling our highly appreciated CA rental. (Bought for $180K, would sell for $1m +.)

We moved back in and remodeled. So added a lot to basis. We’ll live here for several years to get $500k fed tax exemption. We’ll hopefully have $50-$100k in harvested losses from stock/bond funds. And we’re early retired so have modest taxable income.

That’s the plan, though we’re liking this remodeled home pretty well and may just stay put. :happy
I hope you read fyre4ce's post above on this topic.
Sure I read the post. Not sure how it would apply to our situation though unless you suggest not trying mitigate the capital gain.
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Nate79
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Re: About to sell a rental house and take cap gains hit

Post by Nate79 »

goingup wrote: Thu Jan 27, 2022 6:12 pm
Nate79 wrote: Thu Jan 27, 2022 5:54 pm
goingup wrote: Thu Jan 27, 2022 5:48 pm I know not everyone wants to do it this way, but here’s how we are handling our highly appreciated CA rental. (Bought for $180K, would sell for $1m +.)

We moved back in and remodeled. So added a lot to basis. We’ll live here for several years to get $500k fed tax exemption. We’ll hopefully have $50-$100k in harvested losses from stock/bond funds. And we’re early retired so have modest taxable income.

That’s the plan, though we’re liking this remodeled home pretty well and may just stay put. :happy
I hope you read fyre4ce's post above on this topic.
Sure I read the post. Not sure how it would apply to our situation though unless you suggest not trying mitigate the capital gain.
As long as you follow the math of their post as it applies to your situation it's fine (depreciation recapture and % days as personal residence and % days as rental to allocate the gain to each).
fyre4ce
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Re: About to sell a rental house and take cap gains hit

Post by fyre4ce »

goingup wrote: Thu Jan 27, 2022 6:12 pm
Nate79 wrote: Thu Jan 27, 2022 5:54 pm
goingup wrote: Thu Jan 27, 2022 5:48 pm I know not everyone wants to do it this way, but here’s how we are handling our highly appreciated CA rental. (Bought for $180K, would sell for $1m +.)

We moved back in and remodeled. So added a lot to basis. We’ll live here for several years to get $500k fed tax exemption. We’ll hopefully have $50-$100k in harvested losses from stock/bond funds. And we’re early retired so have modest taxable income.

That’s the plan, though we’re liking this remodeled home pretty well and may just stay put. :happy
I hope you read fyre4ce's post above on this topic.
Sure I read the post. Not sure how it would apply to our situation though unless you suggest not trying mitigate the capital gain.
He means my first post, about moving into a rental property. When you do this, the calculation is different and less favorable to getting gains excluded. It’s not as simple as “move in for two years, exclude $250/500k of gains”.
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goingup
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Re: About to sell a rental house and take cap gains hit

Post by goingup »

fyre4ce wrote: Thu Jan 27, 2022 6:33 pm
goingup wrote: Thu Jan 27, 2022 6:12 pm
Nate79 wrote: Thu Jan 27, 2022 5:54 pm
goingup wrote: Thu Jan 27, 2022 5:48 pm I know not everyone wants to do it this way, but here’s how we are handling our highly appreciated CA rental. (Bought for $180K, would sell for $1m +.)

We moved back in and remodeled. So added a lot to basis. We’ll live here for several years to get $500k fed tax exemption. We’ll hopefully have $50-$100k in harvested losses from stock/bond funds. And we’re early retired so have modest taxable income.

That’s the plan, though we’re liking this remodeled home pretty well and may just stay put. :happy
I hope you read fyre4ce's post above on this topic.
Sure I read the post. Not sure how it would apply to our situation though unless you suggest not trying mitigate the capital gain.
He means my first post, about moving into a rental property. When you do this, the calculation is different and less favorable to getting gains excluded. It’s not as simple as “move in for two years, exclude $250/500k of gains”.
Yes. Thanks for that reminder. I had a case of magical thinking in imagining we'd get the full capital gains exclusion. You prompted me to pull up notes from our old CPA about this. It's complicated. In order to qualify for a partial capital gains exemption, first you must live there for 2 of the last 5 years. Then you prorate the exclusion based on the number of years of non qualified use divided by years owned. So we'll still have a big tax bill...
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