Investment properties lure tax man after sale


But wise investors can keep the bite to a minimum

June 20, 1999|By JONATHAN A. AZRAEL

The people who contact me often have question that go beyond the traditional buying and selling of their personal residence. Many questions come from real estate investors who need quidancewhen it come selling property.

Selling investment real estate usually triggers federal and state income tax on the capital gain. The gain is computed by subtracting the tax basis of the property from the net sales price.

Consider an investor who inherited a rental property in 1990 from his mother. His mother's escome tax returns for depreciation.

The investor sells the property in 1999, receiving a net price of $100,000 after payment of settlement costs and commissions. The investor has realized a gain of $65,000 [$100,000 minus ($50,000-$15,000)].

The investor will pay a 20 percent federal tax on the long-term capital gain, plus applicable state income tax.

Real estate investors often use two techniques to defer the imposition of income tax on their capital gains. These tax savings plans are the installment sale and the tax-free exchange.

Installment sale. Instead of selling the investment property nances all or part of the purchase price by a "take-back" mortgage. The $65,000 capital gain will be recognized in proportion to the principal payments received each year.

If the investor, for example, takes back a mortgage for half of the purchase price, payable over 10 years, only one-half of the capital gain will be taxable in the year of sale. In the example cited, the remaining one-half of the $65,000 capital gain will be taxed over the 10-year payout.

Tax-free exchange. An investor may delay the taxation of the entire gain by exchanging his property for other investment real estate. A vacation home that has been primarily rented to third parties may qualify as exchange property.

A rental property can be exchanged for a home that becomes the investor's principal residence, provided the home received in exchange is rented to others for at least one year after the exchange transaction.

It's also possible to do a tax-free transaction where an investor transfers his property to one party "in exchange" for property to be acquired from another party.

To qualify for favorable tax treatment, the tax-free exchange must be properly documented and comply with legal requirements of Section 1031 of the Internal Revenue Code and Regulations.

Under current tax law, if the investor holds property received in a tax-free exchange for his lifetime, income tax on the capital gain may be avoided completely.

The Sun invites you to send real estate questions to Mailbag. Questions are answered by Jonathan A. Azrael of Azrael, Gann and Franz of Towson.

Questions -- including name, address and daytime telephone number -- may be sent in the following ways:

Mailing address: Real Estate Mailbag, Fifth Floor, 501 N. Calvert St., Baltimore, Md. 21278-0001. Fax: 410-783-2517. E-mail: ten have questions that go beyond the traditional buying and selling of their personal residence. Many questions come from real estate investors who need guidance when it comes to selling property.

Pub Date: 6/20/99

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