yo what's up everybody thanks for
joining me today i'm gonna be talking
about
rental properties and the you know what
to expect
when you're selling them in terms of
capital gains uh
what's all involved in capital gains and
how you can actually avoid
capital gains and you know what things
you can do there
so before we begin i wanted to let you
know there's two components
in uh in taxable gain when you're
selling the property
first there's the actual capital gain
that everybody talks about
and then there is something called
depreciation recapture
which is kind of like capital gains a
little bit different
and i'll go into the details of both and
why it's important
okay so first capital gains that is
actually
when you sell a property for higher than
you bought it for
okay so in order to calculate capital
gains you take the selling price
minus your purchase price minus any
long-term renovations that you made to
the property
and then minus any selling expenses you
know like you pay out realtor
commissions that kind of thing
that is your capital gains pretty simple
formula
capital gains are typically taxed at 15
for
normal income ranged people if you are
in the highest tax bracket then that
that tax becomes 20 and this is
you know the 15 or 20 percent only
applies if you held the property for
longer than one year
if you held it for less than a year then
you are paying ordinary income tax which
is
much less favorable the other component
to a taxable gain of a sale
is depreciation recapture and before i
explain depreciation recapture
i probably you probably want to know
what depreciation is so when you
purchase a property
a rental property uh let's say you buy
one for 270
000 you don't get to just write off the
entire 270 thousand dollars in the year
that you purchased it
that's just not how it works what the
irs requires
is you depreciate the property over time
okay if it's a if it's a business
property you depreciate over time if
it's your primary home
you don't have to worry about
depreciating because you're not using it
for business now if you use
if you rent out like a room in your
house you know for airbnb or whatever
then you would depreciate a portion of
your house over time
so let's say you pay 270 000
for your rental property you're expected
to depreciate over
27 years so that's 10 000 per year
that's the deduction that you can take
each year that you rent this property
out it's 10
000 that's called depreciation
so let's say you bought it on the first
day of the year
uh in 2020 for so for 2020 you'd
appreciate ten thousand dollars
for 2021 you'd appreciate another ten
thousand dollars so now you got a total
of
two twenty thousand dollars of
depreciation
depreciation recapture means that if you
sell the property
for greater than what you purchased it
for
you have to take your total depreciation
that you took
and pay taxes on that depreciation as a
recapture
while you're renting the property out
you're taking this depreciation
deduction
it's offsetting your income it's
offsetting your rental income
and in some cases could offset your
normal ordinary income as well
which is a good thing but then when you
sell the property you then have to pay
taxes on the depreciation recapture
and that tax rate is up to 25
so it's not it's not a total wash you
know what i mean
like if you are taking depreciation
deduction against your ordinary income
your ordinary income might be a uh
a greater tax percentage than 25
so when you go to to recapture your
depreciation you're paying up to 25
percent
as the max so you it's still a benefit
to recapture that depreciation so that's
the two components
in taxable gain when you're selling your
property
you got capital gains and then
depreciation recapture
sometimes people lump them both into the
same terminology when they're talking
about capital gains
and i think that's okay but for the
purpose of this video
it's really important to know the
distinction in when you're trying to
avoid capital gains
slash depreciation recapture so now i'm
going to talk about strategies on how to
avoid capital gains
or depreciation recapture and you know
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and to try to help you guys navigate the
tax law and navigate any relief
covered bills that get passed so there
are three primary methods that you can
use
to either avoid or defer capital gains
okay so there's the 1031 exchange
you can hold your property until you die
and then you can take the section 121
exclusion
and i'll go over all three of these okay
so you've probably heard a lot about
the 1031 exchange if you are in real
estate
it's basically it basically means that
you have your business property
and instead of selling it and paying
capital gains on it
you actually you take that business
property you exchange it for another
property
and you basically don't pay any capital
gains tax when you do that
okay now you're not actually avoiding
capital gains here you're just deferring
it
you know any capital gains that you
would have paid on this property you're
just moving it to your new property
and then you're depreciating it you know
you continue to appreciate it so it's a
good way to move
up in property without paying capital
gains tax immediately
and a 1031 exchange uh covers capital
gains and depreciation recapture
now some people think that you can just
sell a property
and then go buy another property and
then tell your tax guy hey
i i actually just did a 1031 exchange i
just exchanged this for this property
and that's not how it works you actually
have to go through a
qualified intermediary that does 1031
exchanges yeah it's like a very
formal process you know the the money
that you get from selling your first
property gets put into a trust
account and then you have to have
identified some other properties that
you want to purchase within like 45 days
it's a whole formal process you don't
get to just sell a property
buy another one and then decide at that
point that you did a 1031 exchange
that's not how that works
so before you go doing that make sure
you
engage with a 1031 exchange specialist
it's not it likely won't be an
accountant check with your real estate
agent
or your title company to see if they
know somebody that does that
the second way to avoid capital gains is
to hold on to your rental property until
you die
uh you probably heard this where you
know inherited property gets a step up
in basis
now what does that mean that means that
you know your purchase price
that i talked about earlier as your cost
basis
if you die and you you uh will that
property
to maybe your child okay your child gets
a step up in basis
at the time of your death okay so
how you know why is this avoiding
capital gains how does that work
so basically you know i've seen some
clients where they
bought a property like 20 30 years ago
in denver they bought it for maybe like
50 000
okay now it's worth 1.5 million dollars
can you imagine the capital gains on
that the capital gains tax on that
now since it's worth 1.5 million dollars
now
and they passed away and they did all
things correctly their child inherited
it
now that property is worth 1.5 million
dollars of cost basis to their children
so when they sell it immediately that's
okay let's say they sell it immediately
they sell it for 1.5 million
that means you're taking your selling
price 1.5 million
minus their basis which is also 1.5
million
and thus you pay no capital gains there
so that's how you do it by uh waiting
holding on your property till death your
children see the tax benefit there
not necessarily you okay it's your
children
but if you're you're looking for like
more you know estate planning
generational wealth building
that's one way to do it another common
thing that people
think is that once you die and you you
know will a property to your
decedents then the step up in basis is
automatic and that's
not true you have to file form 706 which
is an estate tax return
to tell the irs that this property is
receiving a step up in basis
and this is the new basis at the time of
death
so some some forms do have to be filed
with the irs in order for this to work
it doesn't just happen automatically so
that's why it's really important
when you're planning for your estate or
when a family member passes away
to get in touch with the state planning
attorney and
a good cpa to make sure that all those
things happen
and they get their you know step up the
basis
and all that stuff now the third way to
avoid capital gains
tax is the section 121 exclusion
and this is actually more commonly known
among
uh people who just own the primary
residences it's the rule that says if
you lived in your primary
if you lived in a home as your primary
residence for two
out of the last five years at least two
out of the last five years
then you can exclude up to two hundred
and fifty thousand dollars of capital
gains per person
that means if you're married you can
exclude up to five hundred thousand
dollars of capital gains
sounds great right you know this this
just prevents people from
you know paying a bunch of capital gains
for just wanting to move their family
but how does that tie into rental real
estate
so one common thing that people might do
is they might move into
their rental property for a couple years
as their primary residence
and that way you can exclude you know if
they're married you can exclude up to
500 000
of capital gains now this method
does not include depreciation recapture
attacks
so although you know you might exclude
capital gains
you still have to pay taxes on the
depreciation recapture
this is also something that i see
accountants
missed reports you know very
very commonly they do not report this
correctly
so the taxpayers are out of compliance
you know because there is depreciation
on the property
they don't properly recapture it so it's
a big mess
so just keep in mind if you do this
strategy hire a good cpa just mention
that
there has been depreciation on this on
this property you want to make sure it's
accounted for correctly
now when will this when will this uh
strategy make sense
it would make sense if you've had the
property for a long time
and it has appreciated in value
significantly
even though you'd appreciated the
property for a while the capital gains
is still just enormous this would make
sense
another thing to keep in mind is that
the irs wants to make sure you rent
out a property for at least a year
before you move into it as your primary
residence i mean the longer the better
because then you know you can
legitimately say it was a business
property before
you moved into it as a personal property
and this is actually important if you
choose to do a 1031 exchange into a new
property
some people do that and then they move
into their new property
as their primary residence and while
that
while you can do that i would wait as
long as as you can
you know to make sure because the 1031
exchange is
exchange of a business property for
another business property
so you can't exchange it for a personal
residence
okay so you exchange it for a business
property you should wait as long as
possible
before moving into that property if
that's what you plan on doing
to avoid any trouble with the irs three
ways to avoid
again there's a 1031 exchange there is
holding until you die and then there is
moving into your
your rental property and living in there
for at least
two out of five years oh one more thing
i want to talk about
is there are some i've had a
huge number of clients who did their own
taxes on turbo tax
and turbo tax did not depreciate their
property for them their rental property
so as i said before the irs requires you
to depreciate your property
if it's a rental or if it's used for
business purposes
and for some reason turbo tax might not
make it clear
you know i don't i haven't really
touched turbo tax in a while but they
had their rental property for maybe 10
15 years and never took
any amount of depreciation on it so what
happens there is when you go to sell the
property
you then have to still pay depreciation
recapture tax
even if you didn't take the depreciation
so
in this case you didn't get the benefit
of the depreciation deduction on the
front end
and now we have to pay the taxes for it
on the back end so now you're doubly
screwed
uh there's one way to get out of this
though it's called the change of
accounting method and we've done this
for all of our clients who have this
issue
where you basically can take all your
missed appreciation
and lump it into the year that you sell
the property
and it just offsets the depreciation you
capture that way
so that's filed with form3115 if that is
your
if that is what happened to you be sure
to reach out and we can help you with
that it could save you
tens maybe hundreds of thousands of
dollars all right
that's all i got for today thanks for
joining me again my name is ryan
i'm a cpa be sure to like this video if
you do like it
and found it helpful and i would ask
that you consider subscribing to my
channel
to stay up to date with all these tax
changes
coved relief changes all that crap all
right
so stay safe take care i'll see you next
time
[Music]
they got amnesia