Selling Real Estate Can Be Taxing!

Posted on 06/16/2011

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If you’ve ever sold a piece of property, you know that the title of this post is true. First you must find a buyer, negotiate the purchase price, wait for the building inspection, haggle over the repairs, wait for the bank to give your buyer a loan, deal with title issues and then try to get a least three attorneys to agree to a date and time when they’re all ready to be in the same place to close title! That’s not to mention packing your stuff, or getting rid of a tenant or dealing with the myriad other things that can come up and go wrong in even the simplest transaction.

But that is not what this post is about. Instead, I’m referring to “taxing” in the literal, Sheriff of Nottingham, sense of the word. When you sell a piece of real estate, Uncle Sam will be checking to see if he is entitled to a piece of the pie. So too will state government, and possibly city government as well! And you may owes taxes even if your property is underwater and is being foreclosed upon or being sold in a short-sale.

Tax Rates

Profits from the sale of real estate are referred to as “capital gain” and face as many as four different levels of taxation. Under the Bush tax cuts that were extended by Congress at the end of 2010, the Federal long term capital gain tax rate is currently 15%, however, that rate is scheduled to reset to 20% beginning January 1,2013. On that date, certain high income taxpayers will also face an additional 3.8% Medicare tax on their capital gains, resulting in a combined federal tax rate of 23.8%.

Commercial property sales are also subject to depreciation recapture. To the extent the property owner has been entitled to take an income tax deduction by depreciating their cost basis, they must in a sense repay the tax savings on those deductions at a maximum federal rate of 25%.

On top of the federal taxes, the state where the property is located may also collect income tax on the capital gain. While states such as Florida and Texas do not have income taxes, state rates may be as high as 9.3% in states like California and 8.97% here in New York. And believe it or not, even if you own property in a non-income tax state such as Texas, if you reside elsewhere your home state may impose income tax from the sale of that property!

Finally, may cities and local municipalities also impose income taxes on the sale of property located within their fiefdoms. New York city, for instance, imposes income tax as high as 3.648% on all income derived by residents of its boroughs, including the sale of real estate.

Example

To get an idea how these various taxes play out, consider the following scenario: a four-plex in Astoria, New York sells for $1,000,000. The current owner purchased it for $500,000, and has invested another $100,000 in improvements. They have taken depreciation deductions of $150,000 during the time they have owned the property.

The owner’s capital gain would be calculated as follows:

Sales Price:                                                                                 $1,000,000

Cost Basis

            Original purchase price           $500,000

            +Cost of improvements          $ 100,000

              –Depreciation                            ($150,000)

                                                                                                      –$      450,000

                        Capital Gain                                                  $    550,000

   The tax on the Capital Gain would be as follows:

           $400,000 x  15% Federal=       $60,000   

            $150,000 x  25% Federal=        $37,500

            $550,000 x 3.648%NYC=          $20,064

             $550,000 x  8.97% State=         $49,335

                                    Total                                                           -$   166,899

                                     Net Gain (Profit)                               $    383,101

That’s quite a bite, considering Uncle Sam and his cousins in state and local government never paid a dime toward the mortgage, never picked up a plunger to fix a toilet, and never paid a dime to remove graffiti from the outside walls!

Fortunately, our tax laws provide an important tax break to people who are selling their primary residence, and also offer a strategy for commercial property owners to defer the tax that would otherwise be due on their sale.

I’ll write more about these topics in my next posting.

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Posted in: Real Estate, Tax