Hey what's going on everybody? My name is Ryan, I'm a CPA, and today I'm going to be
talking about capital gains on rental property and how you could possibly,
maybe, just avoid them. But first I would love it if you'd please subscribe to my channel if you're
new here, and if you find this video helpful which I hopefully you will, please smash the
like button. I'd really appreciate that. And then leave me some questions or concerns, comments
down in the comment section below alright. Now before I get started I think it'll be a good
use of your time to watch one of my previous videos
on the sale of your primary home and how capital gains are treated that way because that could,
because I'm going to reference that video in this video. So maybe after you finish this video,
if you haven't seen that one already, go back one or two weeks and check out that video. In
terms of capital gain when you have a house, when you have a property, if you sell it for a profit,
you sell it for more than you purchased it for then you will likely have a capital gain
in which you have to pay taxes on. Again how is capital gains calculated? It is the selling price,
minus your purchase price, minus any improvements you made to the property,
minus any selling expenses that you incurred while selling. And that includes like realtor fees and
commissions you know, title title fees and all that stuff. So at the end of all those numbers you
will have your capital gains. And you're asking well what about the the loan amount? Like what
if you had some, a little bit of loan left and you pay that off, does that get factored into reducing
your capital gains? No, the loan amount does not matter because that's money that you borrowed
and you're just paying it back. I have other clients asking me what if I just buy a house,
buy another house real quickly? You know what if I just took the money and spent it on another house,
would I avoid capital gains that way? And the answer is no. Well I mean there's, there's a way
that you can do that but you can't just sell your rental property and then buy another one and say
that you did something that avoided capital gains. Because that process is called a 1031 Exchange.
It's a very formalized process that you need to do ahead of time, before you sell your house.
Something that you have to get started before you sell your property in order to qualify, and
to properly do a 1031 Exchange. That's something I'm not going to really go into detail about in
this video. But just know that if you already sold your property you can't do anything now to avoid
the capital gains by purchasing another house. Alright, so if you have rental property then
you're probably familiar with depreciation. Now this is actually different from capital gains.
You notice when I, when I gave you the capital gains formula I didn't mention depreciation
because there's a different kind of tax for depreciation recapture.
Capital gains as you know, is typically taxed at 15% for long-term capital gains. If you, and
if you fall under the highest tax bracket, that will be taxed at 20%. Well depreciation recapture
is taxed at up to 25% okay. So if you own rental property, you should be depreciating that property
over a 27 and a half year life. You know, each year you depreciate a little bit of it
at a time so when you sell a property you have to recapture all those depreciation costs as
depreciation recapture income. And like I said that tax is up to 25% of that depreciation
recapture. Now this is important because there is a big distinction between capital gains
and depreciation recapture and I'm going to talk about how why that matters in the next few points
I'm going to make. As you can see here in this diagram I kind of gave you an example of what it
would be like if you had a property depreciated over time and then sold it at a profit okay.
That means you sold it at a higher price than you purchased it for. You're going to
see the differences between the depreciation recapture area and the capital gains area,
and then in this diagram you'll see kind of a similar example. Except in this diagram, let's say
you sold the property for a loss, meaning you sold the property for less than you purchased it for.
Now you still have the depreciation recapture tax but you won't have any capital gains because you
sold it for a loss all right. So now I'm going to give you a couple ways on how you can avoid
paying capital gains tax. Now keep in mind that both of these ways
will really, will require you to be very committed and dedicated to not paying capital gains.
And keep in mind that these two methods also might even cost you more in the long run than paying the
actual capital gains tax. But you know I get so many questions on how, good ways that people can
avoid capital gains. So here we go. The first one requires you to be very committed okay. You had a
rental property that you've been renting out for many years, you're looking to sell it now but you
don't want to pay the capital gains tax because maybe it's appreciated so much in, in value that
you know, the tax bill is going to hurt you. So what do you do? One thing you can do is
move into the property. You know, you you get your tenants out of there whether their lease is up or
you evict them or whatever. Hopefully you don't evict them but you uh, you get them out of there,
and then you move into the property, and live there as your primary home for at least two years.
Now this is important because in the other video I talked about the Section 121
Exclusion. It requires you to live in your home for at least two years and to own the home for at
least two years in order to exclude up to $250,000 of capital gains per person. If you're married
that number becomes $500,000 okay. So if you move into your house, into this house for two years,
and live there as your primary home, and you sell it two years later or greater,
then you can exclude a bunch of gains. Now this is a pretty solid plan but just keep in mind you
can only do this once every two years, first of all and you know it's kind of a headache to
move houses just to avoid gains, and then sell it just to move again. So like I said this you know,
this strategy can save you a lot of money but it's going to require a lot of commitment on your part.
So maybe not the best strategy in this, in my opinion. Unless you really, you know probably
easiest if you have no kids, maybe if you're unmarried, or if your spouse is cool with it.
You know it's, it's a huge uprooting of your life in order to do this. So many people, I tell my
clients this and many people are like nope don't want to do that. The second way to avoid capital
gains is to just hang on to the property and don't sell it. Obviously if you don't sell it, you're
not going to get any capital gains. But the the kicker here is if you hold on to it until you die,
whoever inherits the property gets a step up in the basis. Which means you know, in my
original capital gains formula I told you about where you have you know, selling price, minus
purchase price. Well essentially, the purchase price portion gets stepped up to market value
when somebody inherits the property. If you bought your property for let's say $300,000 and then
by the time that you die it's worth a million dollars okay.
And then you die, maybe your son or your daughter inherits the property, now their purchase price
or their cost basis is now a million dollars. So if they sell it right away for a million dollars,
then they have zero capital gains, and they keep the entire million dollars assuming there's no
loans on the property. And this is essentially how generational wealth is built. You know,
a lot of wealthy people have real estate or have a hand in real estate in some form or other because
of the appreciation in those assets. And if it gets passed down or inherited the capital gains
essentially goes away. The real, the big real cost here is you lose liquidity. That means your money
is tied up in property. You can't access it unless you sell it. So if you don't want to sell it,
then it is all tied up there. If it's an income generating property, hopefully that softens that
issue a little bit but that is the real cost here. These are things to think about when you purchase
rental property. You know, will you be selling it soon, or do you want to hang on to it for a while,
or do you want to hang on to it forever. You know, things to keep in mind. Don't just go
buying rental property without a plan, without a short-term plan, and a long-term plan because that
could cost you a lot of money in taxes in the long run, all right. So that's all I've got for today.
Thanks for joining me. And again, if you found this video helpful, please smash the like button.
And if you're new here, I would love it if you'd consider subscribing to my channel
for more useful information. All right so that's all I've got. Take care for now. Stay safe.