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Selling a rental property


Dear Tax Talk,
My father is considering selling his rental property. He's had the property for over 30 years and has taken full advantage of the depreciation factor. Besides a 1031, what other options are available to him to lower or minimize his long-term capital gain? And what percentage of taxes could he expect to pay? The property has appreciated nearly 50-fold, if one believes the going market rate in the surrounding neighborhood. -- Jimmy

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Dear Jimmy,
Short of death or Section 1031, it's hard not to pay taxes.

If your father were to pass away, then the value of the property is stepped up to its value at his date of death. That solves the tax problem, but it's not good tax planning.

If your father wants to continue his investment in property, he can certainly Section 1031 the fully depreciated rental for another property. Section 1031 involves the exchange of rental property for similar rental property without having to pay capital gains on the sale of the property. As an alternative, your dad might want to consider borrowing against the existing property as a way to finance the acquisition of additional properties.

For example, if the current property is worth $500,000, he could easily borrow several hundred thousand tax-free to purchase additional properties. This way he retains control of the existing property and its continuing appreciation, and has the ability to acquire additional properties. It's practically the same as the like-kind exchange of the existing property without the transaction costs of the sale. Of course, other factors may influence the sale such as future prospects of the property, liquidity needs, etc.

If the property were sold, your dad would pay tax on the depreciation he claimed at 28 percent and would pay capital gains tax at 15 percent on the remainder of the gain. If your dad had capital losses (for example from stock trading), he could offset these losses against the gain and reduce the amount he pays tax on at the 15-percent rate and, assuming enough losses, cut into the 28 percent gain.

-- Posted: May 26, 2004




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