Sale of Industrial Property Will Result In Large Tax Bill
Ask the Real Estate Lawyer: Real Estate Law Q&A
REM # LAW 728
By Ilyce R. Glink and Samuel J. Tamkin
Summary: A ThinkGlink reader made a great
investment in industrial property and will make a large amount of money on the
sale of the property. Unfortunately, this will result in a large capital gains
tax and will also affect his income tax. Ilyce and Sam have some suggestions
for cutting the tax bill.
Q: Three years ago, I bought an industrial property for $55,000 and made some
major improvements to it. I plan to sell it in another three years for $1,500,000.
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If I pay capital gains taxes on the property, will I still have to pay income
taxes? And if I do have to pay income taxes, can I defer them by buying another
property? I need cash so I can’t enter into a 1031 tax-free exchange.
A: Congratulations. It looks like you have made a great move on your real estate
But you should know that real estate has a funny way of affecting Federal income
taxes. If your question refers to paying income taxes on the other money you
receive in addition to the amount of your capital gain, you will have additional
income taxes to pay.
But there are a variety of taxes you must pay when selling real estate. In
simplest terms, if you have profit on the sale of the building and the profit
was due to the ownership of real estate that you held for more than one year,
the profit would be considered capital gains and taxed at about 15 percent (less
for lower income tax brackets) plus state tax.
So if you have $500,000 in capital gains, you can expect to pay Uncle Sam about
$75,000 plus any state capital gains tax due.
In addition to capital gains, you will also have to pay any recapture taxes
on depreciation you have previously taken on the building. If you took $100,000
in depreciation over the time you owned the building, you will have to pay Uncle
Each property is different and your capital gains and depreciation number will
differ, but you need to keep these numbers in mind.
Also, the gain will affect your ability to receive income tax credits and benefits
that are lost due to your high income in the year you sell the property. You
also may be affected by the Alternative Minimum Tax (AMT) and will probably
have to pay more in state tax. Your Adjusted Gross Income (AGI) will certainly
shoot up in the year of your sale and if your state uses this amount to compute
your state tax, you’re going to be in for a shock.
If you sell without a 1031 tax deferred exchange, you will have a substantial
tax to pay, even at the lower capital gains rates. A 1031 exchange is a provision
in the Internal Revenue Code that permits an owner of an investment property
to sell the investment property without paying any taxes on the sale. The condition
on the sale is that the owner must buy a replacement property for equal or higher
value within a certain time period after the sale of the original property.
You should probably sit down with a 1031 specialist in your area to figure
out if you can obtain financing for the property. The financing would give you
some cash now. When you sell the property, you then could buy a replacement
property without paying taxes on the sale.
Before you do anything, talk to an accountant. It’ll be worth the time
and money to look at both the 1031 and selling and cashing out scenarios side-by-side
to see what looks best to you.
If you are absolutely intent on selling and cashing out, you should seek out
a good accountant to help you work through what will undoubtedly be a headache
of a tax season.
Samuel J. Tamkin is a Chicago-based real estate attorney. Ilyce
R. Glink’s latest book is 50 Simple Steps You Can Take To Sell Your
Home Faster and For More Money In Any Market. If you have questions for
them, write: Real Estate Matters Syndicate, PO Box 366, Glencoe, IL 60022
or contact them through Ilyce’s website www.thinkglink.com