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Sale of a Rental Property Tax Consequences & Depreciation Recapture

welcome back to our Channel clear Valley

tax my name is Brian Kim I'm a certified

public accountants and today we are here

to talk about the sale of a rental

property so the full equation for

calculating this out is the sales price

minus cost basis will equal your gain

okay so there's three pieces right the

sales price is straightforward the gain

is straightforward it's the cost basis

that trips up everybody or nearly

everybody so we're gonna break this down

for you okay so you have sales price you

have cost basis and you have your game

so the sales price that's a very

straightforward if you sold your

property for 400,000 then your sales

price is 400,000 straightforward there's

no tricks it is what it is it's very

straightforward cost basis okay okay

cost basis here okay these are the

things I'm gonna have to read this one

off okay so cost basis is the purchase

price of the home okay

how much did you purchase the property

for plus the closing costs of when you

purchased the home okay so we'll get

into that plus the closing costs of what

you sold the property

okay well I'm I'm using the word home

and property interchangeably okay so the

closing cost of the home when you sold

the property plus improvements or

additions that you made to the property

and then you subtract the depreciation

that you've claimed over that property's

history you know so you're gonna have to

look at the prior year tax returns or

just look at the accumulated

depreciation balance so we're gonna dive

into all points all those points one by

one okay so the cost basis the first

bullet point that we mentioned was the

purchase price of the home piece of cake

how much did you purchase the property

for you know there's no there's no

tricks there purchase price in the home

okay moving on the closing costs the

closing cost of when you purchased a

property okay those are gonna be title

charges they're gonna be transfer taxes

they're gonna be settlement costs are

gonna be attorneys fees you know they're

going to be on the HUD statements or the

settlement statement of when you

purchased that property if you bought

that property ten years ago you got to

dig up there that document from ten

years ago you know they're they're all

gonna be listed on that statement the

HUD statement or settlement statement so

you need to you need to dig that up

because you know from our experience you

know those are going to be in the you

know ten thousand or more you know it's

it's a really big number you do not want

to miss those so dig that up dig up the

Hudson or Salomon statement from when

you purchase the property okay moving on

to the next bullet point was the same

thing but it's on the sale side of it so

you just closed on the property got it

right so the closing cost of when you

sold a property you know those will be

this those will be the same things you

know the the title charges transfer

taxes settlement cost attorneys fees etc

but additionally you know what you're

not gonna find on the purchase side is

that when you sold it usually you're

gonna have well if you work with a

broker or a realtor you're gonna have

the Commission's and those are gonna be

huge you know generally they're gonna be

large generally they're gonna be you

know anywhere from five to six percent

if they're not or you know you you still

the property yourself you know that's

great you save money but even on the you

might have had to pick the buyer side

Commission so please do not miss that

especially the Commission's that is huge

okay so those are the closing costs of

when you sold the property and what you

bought the property so don't forget

those you need to dig up those

statements on the sale and when you

purchased it okay and then you're gonna

have the improvements or the additions

that you made to the property during the

course of the

properties life so if you you know

upgraded the the home in any way you

know you do not want to forget that

because that's gonna increase your cost

basis which is good which is good for

the tax equation so if you made an

addition or you didn't remember

remodeling so you know you should have

captured that on the Schedule E when you

were filing your taxes for the rental

activities during that year but if you

didn't still please don't forget those

and you know if you did capture those on

your schedule II in the year that it did

occur okay good just don't forget to add

that to your cost basis okay so those

are those are the four additions to the

cost basis to purchase price of the home

closing costs when you bought the home

closing cost when you sold the home and

the additions or improvements that you

made for the home you know so those are

the four cost basis items that will

increase the cost basis which is good

okay because that's gonna reduce your

game now the one thing that you subtract

in the cost basis calculation will be

the depreciation that you've claimed so

for this you need to see what your

accumulated depreciation is accumulated

depreciation is for that property for

that the life of that property because

that's going to subtract and reduce the

cost basis okay so you're gonna have a

sales price minus your cost basis and

that'll give you your game perfect but

you know that's you have your game but

what rates what rates are you gonna use

is that you can't say oh it's gonna be

15 percents you know the federal

long-term capital gains rate no it's not

that simple because you need to take

into consideration depreciation

recapture when you sign the property for

a game okay so before we get there let's

give an example of calculating

the cost basis so you can see it and you

can work with it you know you can work

with me through this to see what your

own eyes how this calculates how it

flows so I'll just read off an example

so in this example let's say you sold

your property for $400,000 okay property

sold for $400,000 now let's figure out

the cost basis let's say you bought the

home you bought the property for us

$300,000 okay closing costs when you

bought the home or $5,000 got it

you made improvements to the home for

$15,000 okay that's gonna increase your

cost basis the closing costs when you

bought the home will increase your cost

basis the improvements that you made to

the home will increase your cost basis -

closing costs when you sold the property

we're let's say $20,000 so that's gonna

increase your cost basis by $20,000 more

okay so let's say in this example the

depreciation that you've claimed on the

life of the property is $50,000 okay so

what is the cost basis now so the cost

basis is the $300,000 that you bought

the home for plus the 5,000 of closing

costs when you bought the home plus

$15,000 of the improvements that you

made plus the $20,000 of the closing

costs when you sold the property minus

the 50,000 of depreciation expenses the

accumulated depreciation that you

claimed or the course the property's

life okay so now you have a cost basis

of 290 thousand dollars you sold the

home you sold the home for four hundred

thousand so that's a game of 110

thousand okay so it's not going to be a

hundred ten thousand dollars of game

time

18% federal income taxes no that's not

how it works okay because you're

ignoring something so crucial which is

the depreciation recapture and the

depreciation recapture has its own rates

so let me just give you the quick back

story so each year on the Schedule E

that's the rent selectivities income and

expenses you are claiming a depreciation

expense okay and that's helping you

you're benefiting you're claiming

depreciation expense you know you don't

get that for free you know it's gonna

come back to bite you and you know you

you you can't do anything about it when

you sell the property that's called

depreciation recapture you get the

benefit as you're renting it out but you

don't get the benefit for free it's kind

of like a tax deferral mechanism where

you get the benefit in those current

years and then it comes back to get you

when you sell the property

you know the appreciation recapture okay

we're not gonna talk about all the tax

tricks that you can do to avoid that you

know like kind exchanges or opportunity

funds we're not gonna talk about this

we're talking about just a straight-up

sale the property you know you want the

funds so there's none of the deferral

mechanisms and you're going to face the

depreciation expense the depreciation

expense recapture okay so the tax in the

game in this example if we're saying

that you have a hundred ten thousand of

gain you have to know what your

accumulated depreciation was right it

was fifty thousand in this example

that's important because the

depreciation recapture rates are twenty

five percent you know much higher than

the 15 percent for long-term capital

gains rates so you will pay the

appreciation recapture rates up to the

extent of how much depreciation you've

claimed on the property so in this

example you've taken fifty thousand of

depreciate

during the course of the property so up

to the extent of $50,000 of gain you

will pay taxes at a rates of 25% on the

first $50,000 of gains the excess the

remaining $60,000 of gains in this

example will get taxed at your long-term

capital gains rates of 15% okay so

that's the difference you know to

clarify let's say the accumulated

depreciation expense was the cumulate

depreciation was 20,000 over the course

of the property and let's let's stick

with the game the total game is 110,000

so in that example you would pay

depreciation recapture rates of 25% on

the first 20,000 and then the remaining

90,000 we get taxed at the 15% rate so

that's why the accumulated depreciation

you have to take that into the

consideration because you're paying at a

different tax rate than your long-term

capital gains rates so you need some you

need to remember that especially if

you're trying to Ballpark you know it's

in the middle of the year your ballpark

what you gain is what your tax liability

is and you want to make an estimated tax

payment so you use the appropriate rate

you need to know that the rate is point

five percent and that might be

substantial if your accumulated

appreciation is substantial you know it

might not be so substantial if you only

rented out your property for one year

two years and the cumulated appreciation

is minimal and in that case if you have

a large game the majority of those games

will be taxed at your long-term capital

gains rates but in the event where

you're renting out for ten years twenty

years or twenty seven and a half years

then that's a situation where probably a

majority of your gains you know it could

be a majority of your gains would be

taxed at twenty twenty-five percent you

know it's a big difference especially if

you're talking about gains on a property

which you know they could be substantial

okay so that is kind of a very in-depth

overview or

about the gain equation for sale a

rental property you know this is not

this is not your beginner or entry-level

stuff for when it comes to the tax

preparation so if you actually could

follow what the heck I was saying during

this video you know kudos to you that's

very impressive you know on your end but

if you have any questions or you need

anything clarified now please leave a

comment or question below I'd be happy

to get back to you so you know please

feel free to take advantage of that so

thanks for tuning in and we look forward

to making more videos thank you so much