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Tax Talk with George Saenz

Ask the tax adviser

Capital gains on the sale of a rental property

Dear Tax Talk:
We sold our rental property, and we are carrying the loan. If we should be paid off, must we just pay capital gains or can the payoff money be held by a middleman so we can transfer this money into another loan (so we won't have to pay capital gains now)?
Ivanell

Dear Ivanell:
When you carry a loan on the sale of property, you are entering into an installment sale for tax purposes. Installment reporting means that you recognize gain on the sale over the period that you collect principal on the loan.

Internal Revenue Service Form 6252 is used in the year of sale and subsequent years to determine the amount of principal that is taxable gain.

As a simple example, let's assume you sold the property for $100,000, all of which you financed in a mortgage. Assume you collect $1,000 in principal in the year sold. Assume further that the property has an adjusted basis of $80,000. Your gain in total is $20,000 or 20 percent of the selling price.

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Therefore, 20 percent of all your principal collections is gain, or for the $1,000 collected you'll record a capital gain of $200. All of the interest received on the mortgage is taxable and should be reported on Schedule B (Schedule A will show up on this link first; Schedule B is on page two).

If there is an early payoff on the mortgage, you must report the balance of the gain in the year paid off. You cannot roll over the gain into a new mortgage, since you received the payoff. There is no such thing as a like-kind exchange in this instance. Of course you won't report the interest you didn't receive.

-- Posted: Jan. 22, 2002

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See Also
Property swaps can save tax dollars
Rental vs. personal property use

Tax pros and cons of rental property

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