Capital Gains Question?
1.) If you purchase a propery to use as a rental for $100,000 with $10,000 from the seller at closing for repair allowance cut to contractor of your choice, then rent out for say 2 years and then sell for $140,000. Would my CG be $40,000 or $30,000?
2.)If you purchase a property and lease/purchase to someone, could you avoid taxable income upon sale by doing a rental contract and then a seperate option to purchase contract, therefore showing intent to rent and upon sale 2 years later pay capital gains or do a 1031 exchange?
Maybe DaveT will chime in and give a more experienced answer, but in my layman's opinion:
1) Your CG could not be $30K because your purchase price was $100K, not $110K. My opinion, it should be $50K, because you really only bought for $90K if the seller deducted $10K for repairs (the seller paid for the repairs, not you).
2) Some people try to go this route, but the strict speaking is your REAL intent with property, which is to sell. My take is that by offering an option to purchase, you have shown that your real intent was to try to sell the property, not rent.
Bottom line though is to review your holdings/tax situation with your tax professional and get their professional, and paid, advice.
Roger
The tax base would be 100,000.......
You gave 100,000 he gave you back 10,000 so you are into it for 90,000 whic is your purchase price. You then added the 10,000 to the base price when you fixed it up bringing you back to the original price of 100,000....so the capital gains would be 40,000 minus any and all fees associted with selling the house.......I am not a tax man but this is my understanding of how it would work.....if I am wrong someone will let us know
Brian
Thanks Roger for your reply. Your right, I'm wondering if it would be 40k or 50k. Does this strategy make sense? Buy rental homes and sell within 2 years, do a 1031 and using equity as down pmt. It seems if I did that a few times that I would then own it quicker free and clear. But is it worth it then to have the higher passive income to pay taxes on or would it make sense to hold property and refinance every now and then to pull cash out and reducing my passive income? Hopefully this makes sense how I am explaining this.
Jill
dakota,
1.) I agree with Brian, your gain in this example is $40K.
2.)I agree with Roger. You are engaged in a dealer transaction. All of your profit on the sale is taxable at your ordinary income tax rate and subject to self-employment income taxes. Capital gains tax treatment and 1031 exchanges do not apply in this situation.
As to your strategy of pyramiding your equity with tax-deferred exchanges, it might take a little longer. Two years may not be enough time to see enough appreciation to make an exchange productive. Also, for your exchange to be tax deferred, you have to keep replacing your relinquished property with another investment property that is at least as expensive as the relinquished property.
While you are reinvesting your equity in the relinquished property, your higher purchase price for the replacement property will not allow you to own any property free and clear unless you add more money out of your pocket to the deal. Otherwise, the best way to own your property free and clear is to keep the property and let your tenants eventually pay off your mortgage loan.
1031 exchanges can be used to increase your cash flow, but seldom will the exchange alone increase your wealth. If you really think about it, high leverage ratios can be an asset protection factor. You may not ever want to own your property free and clear.[ Edited by DaveT on Date 05/15/2004 ]