Sale of Rental Real Estate With Existing Cash Out Refinance Loan

[martinezpc]

Hi everyone,

I have a client that purchased a rental home in 4/2017 that was paid off in cash in the amount of $265,000.00. In year 2018 he made a cash out refinance loan in the amount of $280,000.00, which he used this money to make some improvements in this home. He is planning to sell this rental home this year, and has an outstanding loan in the amount of $275,000.00. He is asking for advice in how much taxes he will pay if he decides to sale his rental home this year.

I'm in the process of calculated that for him, but for some reason I get confused in how to treat the outstanding balance of his loan. I'm aware that in order to calculate his capital gain or loss, I will need to first determine the adjusted basis of this home. I will consider the following: cost of basis + improvements+ expenses when purchased minus depreciation over the two years= adjusted basis. In his case it will look like this:
$265,000 Cost + $40,000 (improvements=expenses) - $16,528 depreciation=$288,472.00 (adjusted basis). If he sells this year, the value of the home is $465,000.00 - $288,472.00 (adjusted basis)=$176,528.00 gain. Do I need consider the amount of his outstanding loan on this calculation? He falls under the 15% tax bracket.

Please advise.

[BOB W]

Outstanding loan balance has nothing to do with gain or loss.

[TaxGuyBill]

I agree with Bob.

You mentioned he falls under the 15% tax bracket, but I assume that is BEFORE the gain. After the $176,528 gain, he will likely be in a MUCH higher tax bracket. :-)

[BOB W]

I believe it is the first $39,000 (?) that is tax free. After that it will max out at 15%...… I better check my numbers?????

[BOB W]

If single, his fed tax would be about $19,192

[TaxGuyBill]

If single, his fed tax would be about $19,192

It is difficult to come up with a good estimate without all of the information (and did you factor in the gain due to depreciation being taxed at regular tax rates?). We don't know the amount of his other income, as well as other situations. For example, that 'extra' income could affect how much Social Security is taxed, the Earned Income Credit, the Premium Tax Credit and more. Hypothetically, the right situation (especially the Premium Tax Credit) could result in him owing twice the amount of your estimate.

So the OP should really input all information into a tax program to see the results.

[RWG1950]

Maybe I'm missing something in the post.
If the person had the $265-K in hand, why would he use it all to buy the property outright, only to incur the re-fi costs for $280-K possibly less than a year later ?
Seems like a rather expensive way to obtain $15K.

[BOB W]

You are correct there are too many variables for a down to the penny estimates. The point that I was making was how a LOW tax bracket would effect the tax on the long term capital gain. Single gives $39,375 zero tax and Married Filing Joint gives $78,750 zero tax as long as T/P is under certain tax brackets.. How far under when Depreciation Recapture is considered remains unknown, as well as the other issues you presented.....

In a situation like this proper planning would include as much deferral of other income until 2021 in an effort to keep tax bracket at or under the 15% tax bracket. With IRA deferral available would be a good start...…….. but we don't know much about the T/P...……..

[Burke]

Hi everyone,

Do I need consider the amount of his outstanding loan on this calculation?
Please advise.

OP's original question was answered by Bob W reply which was correct. Borrowed money (mortgage) has nothing to do with calculation of gain/loss.

[BOB W]

Maybe I'm missing something in the post.
If the person had the $265-K in hand, why would he use it all to buy the property outright, only to incur the re-fi costs for $280-K possibly less than a year later ?
Seems like a rather expensive way to obtain $15K.

Mortgage closing cost would of been similar at purchase or refinance... Plus the delay in closing had it been financed at time of purchase. I can see a refi after purchase after it was determined what needs to be upgraded to get best price when resold...

[martinezpc]

Hi everyone, thank you so much for your responses. I think my last question should have been, will the the outstanding balance of the loan ($280,000 ),be deducted from the sale price to determine the gross proceeds of the sale that will be reported on the 1099S? if not, is this because it's a cash out loan?

[Lion]

No. The gross proceeds of the loan ARE what is reported on the 1099S. No. It's because the gross proceeds ARE the gross proceeds.

[martinezpc]

Thank you all for your help!

[BOB W]

Hi everyone, thank you so much for your responses. I think my last question should have been, will the the outstanding balance of the loan ($280,000 ),be deducted from the sale price to determine the gross proceeds of the sale that will be reported on the 1099S? if not, is this because it's a cash out loan?

Let's follow the logic.... The sales price is the sale price and that is what the 1099s reports. If he had no mortgage, he would have the full amount of the sale minus any closing cost. Since he did have a mortgage it means that he already got some of the sale proceeds before the date of the sale, a year or so before. So there should be no thought the mortgage would be an expense of the Sale! He got every penny in his pocket over time...….

[martinezpc]

Thank you Bob, this makes sense now regarding the outstanding loan.