Lecture 23: Taxes from Sale

Learning Objectives
  • Understand different types of transactions and their associated tax liabilities.
  • Calculate tax liability from property sales.
  • Accurately account for selling expenses, mortgage balance, and depreciation recapture.
Types of Transactions and Taxes
  • Fully Taxable Transactions
    • Occur when the seller receives full payment in the sale year.
  • Tax-Deferred Transactions
    • Include Section 1031 "like-kind" exchanges.
    • Opportunity Zone investments (Tax Cuts and Jobs Act).
Fully Taxable Sale Cash Calculations
  • Adjusted Basis:
    • Comprises the original acquisition price (including land and building).
    • Adjusted for additional capital expenditures (CAPX) and accumulated depreciation (depreciation recapture).
Case Study: Centre Point Office
  • Total Acquisition Price: $1,056,000
    • Building: 80%; Land: 20%.
    • No personal property or acquisition expenses.
  • Rental Income:
    • Eight office suites (2 at $1,800/month, 1 at $3,600/month, 5 at $1,560/month).
    • Annual market rent increases by 3%.
  • Operating Costs:
    • 10% vacancy and collection loss.
    • Operating expenses: 40% of annual effective gross income (EGI).
  • Holding Period: 5 years; expected sale price calculated from Year 6 NOI capitalized at 8.75%, with 4% selling expenses.
  • Mortgage:
    • 30-year fixed rate of $792,000 at 6.5% interest, 3% upfront financing costs.
  • CAPX:
    • 5% of annual EGI totaling $43,004 over 5 years.
Depreciation Details
  • Total Depreciation: $108,308 over 5 years.
Tax Rates
  • Income tax rate: 30%
  • Capital gains tax rate: 15%
  • Depreciation recapture tax rate: 25%
Concept Check 1: Find Adjusted Basis
  • Calculate based on acquisition prices for land/building and adjustments for CAPX and depreciation.
Taxes Due on Sale
  • Utilize adjusted basis to determine taxable gain from net sales proceeds.
  • Split taxable gain based on capital gains and depreciation recapture rates.
  • Compute individual tax liabilities and sum them for total taxes due.
Understanding Depreciation Recapture
  • IRS taxes gains from asset sales that have previously offset ordinary income through depreciation:
    • Example: Purchased property for $100,000, sold for $110,000 after depreciation.
    • Gain: $35,000; tax implications: $10,000 at capital gains (15%), $25,000 at recapture (25%).
Case Study Conclusion: Centre Point Office
  • Expected sale price in Year 6: $1,180,469, after deducting 4% selling expenses.
  • Net sales proceeds = Expected sale price - Selling expenses.
  • Adjusted basis and split taxable gains according to tax rates are crucial to calculate final taxes due.
After-Tax Cash Flow from Sale
  • Calculate by:
    • Starting from sales price after selling costs.
    • Subtract outstanding mortgage repayment.
    • Subtract total taxes due to get after-tax cash flow.
Case Study Summary: Centre Point Office
  • Expected Sale Price:
    • Year 6 NOI capitalized = $1,180,469.
    • OLB (Outstanding Loan Balance) = $741,399.
  • Taxes Due:
    • Capital gains = $34,246 → $5,137 (15%).
    • Depreciation recapture = $108,308 → $27,077 (25%).
    • Total taxes due: $32,214.
Concept Check 2: Compute Taxes Due on Sale
  • Complete tax calculations based on provided numbers.
Concept Check 3: After-Tax Cash Flow Calculation
  • Compute again after taking into account all deductions.
Concept Check 4: Hypothetical Scenario
  • Problem: Purchased an apartment for $1 million, original depreciable basis was $750,000.
  • Annual depreciation deduction was $27,272.73 leading to total depreciation of $136,364 over 5 years.
  • Selling property today for $1,270,000 involves calculating taxes due on sale with given selling costs and tax rates (ordinary income: 33%, capital gains: 15%, recapture: 25%).