Cash-out Refinancing - Effect On Basis?
If I buy a house for 100k, and it's depreciated by 20k, that gives me a basis of 80k in the house.
Let's say the FMV of the house has gone up to 150k and I want to use cash-out refinancing (at 80% LTV) to get to that money so I can use it towards a new property.
If the mortage is at 90k when I do the refinancing, then I'd pocket 30k (.8 * 150 - 90), but what happens to the basis? Does the basis go from 80k to 110k (80 + 30)?
The reason I ask is because come time to sell the house, the gain is gonna determine my tax liability. So I want to know where the taxes on that 30k come into the equation.
Edit: Typo[ Edited by mwinburn on Date 10/28/2003 ]
I believe a refi has nothing to do w/ your basis. Your basis would still be $80,000.
I agree that your basis is not affected.
Your basis is what you pay for the house. You are saying it went down in value to 80k then up to 150k? What is used for capital gains is what you buy it for and what you sell it for and if it rental you have to re-capture the depreciation you took. If its your primary then its tax free gains or losses if you sell it for less than you bought it.
Quote:
On 2003-10-28 10:25, rgibson wrote:
Your basis is what you pay for the house. You are saying it went down in value to 80k then up to 150k? What is used for capital gains is what you buy it for and what you sell it for and if it rental you have to re-capture the depreciation you took. If its your primary then its tax free gains or losses if you sell it for less than you bought it.
Your post is mostly correct, but let me clear up the muddy points. Your basis is not what you pay for the property, but what you pay for the property less any depreciation you've taken on it. So mwinburn is correct, if you pay $100,000 and depreciate $20,000, your basis is $80,000. When your basis is lowered because of depreciation, it is incorrect to say that the value is lowered to $80,000. That is the single best thing about real estate, in my opinion. You can take a tax deduction for depreciation, when in reality the property is appreciating. When you sell a rental property, assuming you do not do a 1031 exchange, your gain will be the difference between what you sell it for and your basis. In the example given, the gain will be 150,000-80,000, or 70,000. 20,000 of that gain will be depreciation recapture, the remaining would be a 1231 gain.
You're right, you can not take a loss on your personal residence, and the gain is not taxable subject to restrictions.
So when I sell it, if the basis doens't go up, then I may end up in a situation where I owe more in taxes than I made in the sale. i.e. A gain may be recognized as 100k, which would be roughly 25k owed in taxes, but I only got 15k out of the sale.
Obviously if I roll this into a 1031, I can defer paying taxes, but the fact remains I still owe more than I have because the extra 10k that is owed in taxes is tied up somewhere else (and is represented by the amount of money pulled out via the refinance).
So, does that mean that when you refinance the cash is taxed then or is it not taxed until later on?
Edit: Clarification - the numbers in this post have nothing to do with the numbers in the first post. I'm just trying to get a quick example of a situation where I would owe more than I got in cash from the sale, so I can ask questions on the tax ramifications.[ Edited by mwinburn on Date 10/28/2003 ]
You are correct. If you do sell for 100k gain, and your property is leveraged above your basis, you may have a situation where your proceeds may not cover your tax burden.
And obviously that wouldn't have happened if you hadn't cashed out your equity. You cashed out your equity to use leverage to your advantage.
Also, I'm trying to think of a situation where you would sell soon after you cashed out anyway. If the property is producing income, then there is no reason to sell. If the property is not producing as much income as you like, then why would you cash out your equity in a refi? Wouldn't it be smarter to sell outright, and invest the funds in a more productive asset? And if you did a 1031 exchange, you could still use the whole proceeds.