there are a lot of videos out there
about running the numbers for a rental
property when you buy it or when you
already own it but what about running
the numbers when you sell a rental
property especially how do you know how
much you're gonna pay in taxes when you
sell my business partner and i have
bought sold and still own over 100
rental properties it's our main source
of income and every once in a while we
sell one of our properties so in this
video i want to show you the details of
one particular rental property that we
sold not too long ago i also want to
show you how i calculated how much i
would owe in taxes after that sale and
don't worry if you're not an expert in
accounting i'm going to explain this in
simple terms that anyone can get and i'm
also going to offer a free spreadsheet
calculator towards the end of the video
so stick around and let's get started if
you're new to the channel i want to say
welcome my name is chad kersten you can
also call me coach and this is a channel
all about investing in real estate
achieving financial independence and
doing more of what matters right from
the beginning i want to let you know
that the tax side of real estate
investing is something not talked about
enough and that's why i'm making this
educational video i also want to remind
you that taxes can get complicated and
every individual situation is a little
bit different so i recommend that you do
like i do and hire a professional like a
cpa or a tax attorney to help you
actually advise on your particular tax
situation so before we get into all the
numbers and the tax implications i want
to give you some background on this
particular rental property just so you
can get some context this rental house
is one we bought in 2006 it's a three
bedroom one and a half bath ranch style
brick house so very typical for our area
in the upstate of south carolina we
bought it in 2006 and we sold it in 2019
so we ended up holding on to it as a
rental property for a little bit over 13
years i want to say up front that this
was not a great deal for us it wasn't
the best end result we ended up not
losing money on it but we had negative
cash flow on this property for the first
seven to eight years of the property
ownership part of that was paying too
much for it part of the the financing
that we got in the very beginning was at
a higher interest rate and just didn't
have a lot of room for cash flow because
we were paying so much on the loan and
also probably the biggest issue was
there was a lot of deferred maintenance
there was some upgrades we needed to do
so we couldn't keep really good tenants
the location was decent but we needed to
put a lot more money into this property
to attract the better tenants that we
haven't had on some of our other rental
properties and so we just paid too much
to be able to do that and it's actually
one of the reasons we sold the property
just to move on get our money back and
go and try to find another rental
property so let's take a look at the
simple numbers for this rental property
and in a way in real estate investing or
really any business it really comes down
to how much did you pay for the property
what's your total cost and then what did
you sell it for because if you know
those two numbers you can then subtract
them and figure out the difference which
is called your gain also known as your
profit so in this case we sold the
property for 119 000 that's the price
that our buyer paid for it and our total
cost was 98 500. now i'm going to get
into some details of what that involves
but this includes things like the price
we paid for the property it includes the
closing costs when we bought the
property it includes any improvements we
did to fix up the property and make it
more valuable or any capital expenses
like i'm not sure if we replace the roof
on this one actually we did right at the
end but anything like that any
improvements closing costs and then
commissions and closing costs when we
sold the property all that's lumped
together for now just to keep things
simple but the difference between those
when you subtract 98 500 from 119 000 is
20 thousand five hundred and this is
actually pretty close to what we got as
a check at closing so we paid off our
debts other things we had on the
property and we ended up having a check
for twenty thousand five hundred and you
would think in a simple world you would
just go pay taxes on that whatever the
capital gains tax rate is we're going to
look at that on a spreadsheet a little
bit more detail you think you just pay
taxes on that but there's one other
layer of complication when you own
assets like this when you're in real
estate assets and it's something called
depreciation and before i get into more
of that math i want to take a side trip
here and explain a little bit more about
what depreciation is and why you need to
know about it with a rental property
this concept of depreciation is a tax
term which when you take it outside of
all the normal tax jargon is actually
pretty simple to understand and i want
to explain it to you it just represents
the fact that anything any physical
object in the world deteriorates over
time so you can see my beautiful
artistic rendition here of one of your
rental properties and it starts off
brand new we hope at least most of the
things are working at least when it was
built in the very beginning it was all
brand new but you know from the very
beginning that every single component of
that house has a life span it's going to
wear out at some point whether it's 10
years or 100 years things in that house
wear down for example the roof of the
house if you put an asphalt shingle
might have a life of 20 to 30 years
that's pretty typical and a lot going to
be a lot of variation depending on other
things the brick on the side of the
house might last a lot longer the
driveway may be longer the hegen air
system less than the roof but overall
the irs has acknowledged that your
rental property the physical part of
your rental property is going to wear
out over time and so they there is a
table basically and each component of
the property so the residential building
component of the property they've given
a term of 27 and a half years and so for
tax purposes that just means that your
rental property as a whole wears out
over 27 and a half years according to
the irs so what does that mean that
means that for example if the house
component of your purchase so you have
to separate out the land but if the
purchase price of the house is a hundred
fifty thousand dollars you divide that
by twenty seven and a half so twenty
seven and a half years so you get five
thousand four hundred and fifty four
dollars per year in what's called a
depreciation expense but step back and
think about this you've already paid for
the property up front you either
borrowed the money or used your own cash
so this expense isn't something that
comes out of your pocket every year yes
you might need to put some money for
maintenance you're probably fixing up
some things and you need to set aside
some money for that roof when it
eventually wears out but this is an
expense that doesn't necessarily come
out of your pocket but it is an expense
on your taxes so what does that mean
what if you had five thousand dollars
that year and rental income that you
would typically pay taxes on well if you
have this depreciation expense of more
than five thousand dollars you actually
do what's called sheltering your income
from taxes so this paper loss of
depreciation it shelters your income
from taxes at least the rental income so
that you save money on taxes and that's
one of the big benefits that a lot of
people talk about with rental property
and that's great for a time but the
issue here is that when you go to sell
the rental property the irs gets the
money back so that when you sell the
property even though you've depreciated
it let's say in my case for 13 years and
you've benefited from that tax savings
during that time you have to pay the
piper you have to you have to do what's
called recapturing that depreciation and
you're ending up having to pay taxes on
it in the end and so i want to show you
a little bit more complicated
calculation that i referenced earlier to
show you how depreciation fits into this
equation when you're selling a rental
property remember when i showed you the
numbers the first time i said it's
really simple you got to figure out what
your total cost is you got to figure out
what you sold the property for and the
difference between that is your gain
well i want to show you how it gets a
little more complicated with
depreciation now remember that number
that i had 98 500 that was our total
cost in the property and that included a
purchase price of 83 000 that included
closing costs to buy it of twelve
hundred dollars it included improvements
of five thousand two hundred and
included selling costs which was a
commissions and closing costs when we
went to sell the property of nine
thousand one hundred so that totaled up
to ninety eight thousand five hundred
nothing changed yet the issue though was
the depreciation so during that thirteen
years we benefited from depreciation
expenses in the amount of thirty six
thousand five hundred so we saved some
money on taxes because we offset some of
our rental income during that time but
when we sell it we have to recapture
that depreciation and the way that
happens is it reduces our cost basis and
the property i'll explain what that
means in a second but you take 36 500
and you subtract that from 98 500 and
you get the number 62 000. so our basis
in the property for tax purposes is 62
000 it's as if we bought that property
for a much lower price and what that
means from a tax standpoint is we're
going to owe more in taxes when we sell
it it's like we had a much bigger gain
than we originally did if you just
looked at what we invested in the
property and this is called your
adjusted basis so now that we know our
adjusted basis let's go back to that
original formula to try to figure out
what is the number we actually gained on
this property so we can eventually
figure out how much taxes we owe so here
we are we have 119 500 remember that is
what we sold the property for and our
new cat newly calculated adjusted basis
is 62 500. so when you subtract 62
500 from 119 500 you get a taxable gain
of 57 000
so that's the total amount that the irs
is going to look at and say you're going
to owe taxes on that total amount but
there's a little bit more nuance there
remember 36 500 of that amount is what's
called depreciation recapture so we're
going to treat that in one way when we
calculate taxes and then there's another
portion the leftover portion where we
actually gained on the property the
property actually went up in value of 20
500 and that's going to be treated as
what's called a capital gain so we're
now ready now that we have those two
numbers we can now proceed to the next
step which is let's try to figure out or
at least estimate how much i would owe
in taxes on this rental property now in
order for us to be able to figure out
what you actually pay in taxes on the
sale of a rental property i need to make
a couple of points about how the u.s
federal tax system actually works and
the first point is that as we go through
these calculations keep in mind that the
tax rates that we're going to be using
are my personal tax rates so this is not
a corporate tax rate that's the other
alternative that in most cases mine
including mine but maybe yours as well
you're either going to own a rental
property in your personal name or some
kind of entity like an llc or a
partnership and there's a lot we could
talk about there but the bottom line is
from a tax standpoint you actually don't
pay taxes on the level of the llc
there's not an llc tax rate you actually
have a tax return for your llc but an
off all the income flows through to your
personal tax return and so you're going
to use your personal tax rates that's
the first important point and so in
order to do that you would look at
what's called your taxable income now on
your tax return most of us use on a
personal tax return what's called a form
1040. if you go all the way to the
bottom of that first page there's
something called your taxable income so
that's the number we need to start with
in order to determine what our tax rates
are going to be i want to make a kind of
an aside here is that keep in mind that
your taxable income is not the same as
your total income in fact a lot of tax
planning is about reducing the total
income and the amount of money you
actually make and put in the bank
account and reducing that amount by
having deductions you have things like a
standard deduction on your tax return
but there's also you can contribute to
iras to hsas there's a list of
entrepreneurial tax deductions tax
savings that reduce the total income
down to your taxable income in my case
it's actually a really big number like
my taxable income in that in the year
2019 that i'm going to be evaluating
here was just under a hundred thousand
dollars but the total income was
probably over two hundred thousand
dollars i don't have the total number
right in front of me but it's a big
number if you're contributing to a lot
of these tax deductions so i wanted to
let you know keep that number in mind
but in order for to determine your tax
rates you got to use your taxable income
and there's really two buckets that you
need to think about in your personal tax
rates one of those is called capital
gains tax rates so we're going to look
at some tables here in a second to show
what those rates are depending on how
much money you make and then there's
also ordinary income tax rates and so
the ordinary income tax rates are what
you would use for your salary for rental
income as well and also for depreciation
recapture but there's a little asterisk
there because there's a cap on
depreciation recapture tax at 25 at
least when i'm recording this here in
2021 so let's unpack those a little bit
but i wanted us to get those
distinctions out of the way before we
jump into the numbers so i'm going to go
through two different ways that i have
used to calculate the taxes that i owe
on a rental property the first as you
can see here is a spreadsheet and by the
way you can get this spreadsheet for
free by looking at a link above me here
on the video somewhere or also in the
video description so just click on free
spreadsheet and i'll be happy to send
that to you and what the spreadsheet
does is it helps you to get a rough
estimate of how much you're gonna have
to pay in taxes by basically rounding up
a little bit and i'll show you just a
second how that works and this is so
that you can set aside some money at
least in my case for those taxes in that
moment so you sell that property you get
a check in the bank account and some
people have the temptation to go spend
that money but you need to allocate at
least a portion of that to what you owe
in taxes set it aside if you pay
quarterly taxes you might have to go
ahead and pay it now you could talk to
your cpa and about when you need to pay
that but the point is you need to do
this quickly up front do a rough
estimate and then the second calculation
i'm going to show you is a little bit
more in depth but it's after the fact
when i'm doing my tax return to figure
out how much did i actually owe taxes on
the rental property so let's first go
through this example with the
spreadsheet and so you might be familiar
with these numbers you recognize them
from what i went over them earlier my
purchase price was 83 000. the closing
costs 1200 bucks improvements 5200
closing costs 9 100 so my total cost
basis 98 500 you remember that and the
total depreciation 36 500 so i can get
my adjusted cost basis so i just did the
same math we did on the on the prior
screens and then we figure out what did
i actually make what's my gain or loss
in some cases on the sale of this
property i sold it for 119 000 and by
the way if you're using the spreadsheet
and you want to use it for your own
rental properties the values in red are
the ones you want to change don't touch
the ones in black because those are
automatically going to be calculated for
you and so 119 000 minus 62 000 equals a
57 000 gain that's the taxable gain that
we had on this property so all that's a
review but let's look down here at what
the actual tax rates are so this is
going to be dependent on your state
there's a state tax here as well but
let's look at the federal at least so
remember that 57
36 500 was depreciation recapture and
then 20 500 is capital gains so let's
start with the capital gains that's
actually a little bit simpler and so i
would need to figure out what is my tax
rate for capital gains and if you want
to click you can actually click on a
link i provide there this is just to
another article there's plenty if you
just google capital gains tax rates for
a particular year you'll find all sorts
of
tables out there that show you based on
whatever your taxable income is remember
how we talked about what that number is
taxable income then you figure out which
rate you are and in this case my taxable
income was 15
so that was the bracket that we were in
there's actually a lower one
there's a little bit higher one as well
but this one was 15 for me so that is
what i plugged in here in the
spreadsheet and so 20 500 was my capital
gain on this rental property and that to
be accurate this was actually the total
capital gain between me and a business
partner so remember this is my personal
tax return so actually my portion of
that is just half of that but i'll get
to that in a second so twenty thousand
five hundred was a total gain and the
federal taxes uh would be three thousand
seventy five so there's just a formula
in there that says fifteen percent times
twenty thousand five hundred is three
thousand and seventy five dollars so
that's one portion of it remember
there's the other portion the
depreciation recapture and this is where
it was just an approximation so we just
use the number 25 percent which is the
maximum amount you would pay for
depreciation recapture tax it actually
as you'll see in the next next part
where i go over my actual taxes it can
actually be less than that because this
is your ordinary income tax rate but all
it says is that if your tax rate on this
depreciation recapture is more than 25
then you just cap it at 25 so we're just
using that number as a kind of a worst
case scenario here so 25 times 36 500 is
9125.
and so what is the total there the total
that i owed uh actually my business
partner and i owed if we had the same
tax rates would be twelve thousand two
hundred for federal taxes so out of that
twenty thousand dollars or so that we
put in the bank you know twelve thousand
two hundred would go to federal taxes
that's an important number to know but
we're not done yet because some states
have state income tax depends on the
state you live in some states don't have
any income tax my state of south
carolina does and there's a seven
percent tax rate for ordinary income but
there's actually if you hold a property
over two years this is according to my
cpa by the way thank you brandon smith
in greenville south carolina give him a
little shout out and i'll put a link to
him in the video description below as
well he's pretty busy cpa but has done a
good job for me
so 1686 dollars is the tax rate on the
depreciation recapture and the tax rate
is the same on both of these by the way
unlike the federal level and then 947
for capital gains so i owe additional
tax that we do together of 2633.
so the total taxes on this total game
for this rental property is 14 833 but
my portion so this is a rental property
this is this is a rental company that i
own half of so my portion
i'm going to type that out as we're
going here is
7417. so i'm going to highlight that
right here that is what i would need to
set aside and pay in taxes at least as
an estimate when i ran this calculation
in the very beginning and hopefully you
can use the spreadsheet to run a rough
calculation as well definitely run it by
your cpa get some help with this but
this is actually a spreadsheet that my
cpa helped me put together now i want to
take you through the steps to figure out
what i actually paid in taxes on this
rental property that we sold back in
2019. now remember this is the portion
that is very individual and particular
to you i'm going to show you my income
and what my particular situation looks
like in south carolina selling a rental
property but you want to use a cpa or a
tax advisor to help you out with these
steps that's what i do as well but this
is actually very helpful for me to break
it down and understand it myself how i'm
taxed and i thought it would be helpful
to show you those steps as well so the
first thing to understand here is we're
going to start with the same numbers
that we've been looking at previously
the main difference though is that this
is a personal tax return we're figuring
out how much i personally pay in taxes
and remember i own half of a partnership
that owns this property so all of those
gain figures we had before i'm going to
take half of that to figure out my
personal taxes the second thing is we
want to divide these up again into two
different categories so we have
depreciation recapture that's one
portion here we have capital gains
so let me take you through each of those
calculations starting with depreciation
recapture so what you have to do with
this this is remember taxed at a
ordinary income tax rate so we have to
understand what we make in ordinary
income in order to figure out the tax
rate or the bracket that we're going to
fit in you know the best way to
understand this outside of this kind of
lingo for taxes is to think about the
tax brackets like pouring water into a
big bucket so if you your income is the
water and if you pour your ordinary
income this text at this rate into a
bucket there's different levels almost
like marks on the side of the bucket and
as you fill up the water into each of
those levels each of those levels are
taxed at different rates so the lowest
level is taxed at the lowest rate the
second one's a little bit higher the
third one a little higher we have what's
called a graduated or a marginal tax
rate and or another term for that is a
progressive tax system where the higher
you go in income the dollar the next
dollar you make at one of those higher
bucket levels is taxed at a higher rate
but your lower income levels that first
amount of money you make is taxed at the
lower rate so that's what i'm going to
show you here is that that i made in
2019 if you look at my taxable income on
my tax return it was 99
hundred now remember taxable incomes not
the same as your total income so if you
have a lot of deductions which i
actually did in that case then you can
make a lot more than that and save money
on taxes that's a whole other story if
you wanna know more details about how to
look at that and understand that leave
me a comment and i'll be happy to kind
of add that to my future video list but
for now just understand that 99 100 was
my number and i entered that up here and
out of that 99 100 the portion that is
subject to ordinary income taxes here on
the left side is eighty eight thousand
eight hundred fifty so i've just taken
out the ten thousand two hundred fifty
dollars in capital gains which we're
going to deal with here in a second so
what's left over is 88 850. so that's
like you could think about that as water
in a bucket and out of that 88 850 only
18 250 is my depreciation recapture
portion so what i need to figure out
here now is what part of that bucket is
that depreciation recapture going to be
taxed then what at what tax rate so what
i did here in the spreadsheet is i took
all of the non-depreciation recapture
ordinary income and i figured out what
brackets they would go in so that 70 600
is the total amount of non-depreciation
recapture income and so
19 400 was the first line in that bucket
the first bracket that was taxed at 10
so we filled that one up and then the
rest of that money filled up the bracket
number two and it didn't go all the way
to the top of that bracket it filled it
up to 51 200. so anything above that
that amount in my depreciation rate
capture income will be taxed at 12
so what i needed to figure out was out
of that depreciation recapture income
that i have earned 18 250 how much would
go in that 12 bracket right here and how
much would get filled up in the next
bracket so what i did is i just looked
at the total the top of that bracket is
78 950 and we've already filled up 19
450 1200 so i total those up and the
difference between 78 950 and those two
are 8
350. so that's the amount of space
remaining in that bracket that's filled
up by my depreciation recapture income
and that's going to be taxed at 12
so that's what i did right down here 8
350 and that actual taxes so we finally
got to the number that i'm paying here
is 1 000 and two dollars but i'm not
done yet because remember i have 18 250
in depreciation recapture income and
we've only used 8 350. so the other 9900
fills up the next bracket which is at 22
and that 22 times 9 900 is 2
178. so there we go we finally made some
progress i've got 1002 and 2178 in
federal
income tax on that depreciation
recapture but i'm personally not done
because we have a state income tax in
south carolina and this is a figure i
got from my cap from my cpa and he told
me that 4.62
would be the rate in this particular
situation the long-term capital gains
rate or the it's actually the same rate
for capital gains and depreciation
recapture in south carolina just a
little aside but the rate is 4.62
and so i multiplied 18 250 which is my
depreciation recapture by 4.62 that
gives me 843
so now i know my total amount of
depreciation recapture tax is 4023
so that's kind of interesting to look at
what's my effective federal tax rate
remember when we approximated it on the
prior one i said the maximum is 25 so we
use that to be conservative when i first
sold the rental property but actually
have paid a less less of a tax rate
17.42
because of my personal situation where i
fit into the tax brackets 17.42 so a
lower tax rate but when you add in the
state tax i have a 22 percent effective
tax rate on this depreciation recapture
all right so that's one portion but
we're not done remember we have the
capital gains so let's go back to that
that's a little bit simpler i have 10
250 in capital gains and i have a 15
federal capital gains tax rate for my
personal situation you need to look at a
bracket i've got a link there and a
spreadsheet you can check it out to
figure out what yours is in that
particular year we're talking about 2019
in this case and so 15 times 10 250 is a
1 538
federal capital gains tax remember i
also have state tax so 4.62 times that
same ten thousand two hundred fifty is
four hundred seventy four so i have a
two thousand and eleven dollar capital
gains tax
so we're going to add all these together
we've got 2011 plus 4023 equals a total
tax of 6034
that is how much
tax i actually paid on this rental
property that i held for 13 years that
we rented and then i sold my portion of
that tax was 6034.
so think about this practically if we
made twenty thousand dollars in cash
we put that in the bank and let's say we
distributed that money to the two
partners i made half ten thousand
dollars he made half ten thousand
dollars well six thousand of that gets
paid in taxes so four thousand dollars
left over
i told you this was not that great of a
deal we did save some money on taxes
along the way but at the end of the day
that's about how much money i have left
over on this particular rental property
and my total effective tax rate was 21
so i hope these explanations have been
helpful i know we went in a lot of
detail particularly on this last one if
you got any questions you got any
comments i'd love to hear from you in
the comments section below so you've
been with me from the beginning to the
end to figure out how much i paid in
taxes when i sold a rental property if
you found this video helpful please hit
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you don't miss anything i have new
podcasts that come out every monday and
new videos just like this that come out
every friday and if you like this video
where i go in depth running the numbers
analyzing a real life rental property i
think you'll like my next video which is
about my very first rental property that
i bought 17 years ago i go through all
the numbers and i'll tell you just a
sneak peek the numbers were a lot better
on that particular property we did
better on it but if you want to see the
spreadsheets and the analysis i would
think you'll appreciate and like that
video as well you've been watching coach
carson tv my name is chad carson you can
also call me coach and this is a channel
all about investing in real estate
achieving financial independence and
doing more of what matters see you next
time
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