Thinking About Selling Your Rental? Know Your Options First.

The cost of tax on recapture of depreciation and capital gains. It may become a hidden tax trap for potential sellers.

Capital gains tax, plus the income tax if depreciation is recaptured, may apply when the proceeds are received instead of using an exchange or another compliant tax shelter.

Depreciation recapture is when the depreciated amount of the cost basis may be taxed as income. You may depreciate a residential investment property for 27.5 years to reduce tax, but this entire amount may be recaptured as income at one time if you sell.

Yes. There are legitimate and IRS-compliant strategies that allow the seller to reduce, defer, and mitigate tax and plan how to receive proceeds when selling. The key is to gain the proper knowledge in advance of any sale and determine what is in the seller's best interests.

In simple terms, a 1031 exchange allows for the sale of an investment or rental property with no current tax by exchanging it for a like-kind property. You will carry the prior property's cost basis, depreciation, and debt. A 1031 exchange has a strict 45-day limit on the time allowed to identify a replacement property, and then a further 135-day limit on closing the sale and taking possession. This is known as the 180-day window.

Yes. One generally depreciates the initial purchase price, otherwise known as the cost basis, but improvements add to that cost basis over time and allow for greater depreciation if properly accounted for. The length of ownership also matters: the longer you own, the more you depreciate. One may fully depreciate a property, and then there may no longer be a tax benefit from that source.

Always consult with your personal tax professional before taking any action that may trigger a taxable event. This is a very important step, because once a taxable event or sale occurs, the results are generally not reversible. Always ask the opinion of your tax advisor before taking action on a potentially taxable event.

For the first conversation there is no need for any documentation. The only goal is to educate the owner on their full set of options. Knowing the purchase price and the number of years owned is generally the only information needed initially. Again, education is the goal: owners need to know their options.

Owners sometimes assume the tax bill is unavoidable no matter how they sell, but generally that is only the case if you sell and do not exchange, or do not use other methods of tax mitigation or deferral. That is why getting educated on the options is so important before making any decision to sell or exchange.

I would let them know there are options that allow a sale without an exchange and will fully defer or mitigate the tax cost from that event. The difference between a tax bill or no tax bill on sale is simply getting educated on the options.

The decision to sell is personal. Some want to sell and exit or retire. Some want to sell but not be constrained by the demands of a conventional 1031 exchange. Some want to sell and purchase months or years later. The best option is a conversation, gaining perspective on the potential processes that may benefit the owner, and then involving their tax professional to ensure their best interests are always kept front and center.