This will be one of the most important Real Estate threads I do:

It seems like no one understands how taxes work when you sell a cash flow property

Although this is a very important thread I doubt it gets that much engagement

So make sure to like this shit

Let's get into it:

Introduction:

Before you buy a building you must always look at your exit strategy. If you are buying to hold for 15 plus years than this thread is not very relevant to you.

If you are looking to sell then listen up because taxes on your sale price can make or break a deal.

Next, we must look at if you are doing a 1031 exchange or just selling the building.

If you are doing a 1031 exchange you do not need to worry about recapture and capital gains instead you will just transfer your basis.

The other option is a normal sale:

In a normal sale, there are two main types of taxes:

Capital Gains
Recapture taxes

Capital Gains Tax:

This is a common tax structure that most understand.

When you sell a building for a profit one must pay a tax on their gain.

If held for under a year one must pay normal income tax.

If held for over a year it is usually about 15-28%.

Recapture Tax:

Unfortunately, most investors don't understand this crucial tax step.

A depreciation recapture tax is a tax meant to capture deductions made on income from depreciation.

When you own a commercial building or residential building a common tax write off is to straight-line depreciate your building every year.

Doing this reduces your taxable income and thus the amount you pay in taxes.

But when you make a sale you must pay a recapture tax

Example:

I buy a building for 1M. 10 years later I want to sell and have collected 200K of depreciation write off.

Now my basis is 800k (Simple example)

Now I sell for 2M my taxable gain is 1.2M.

One would assume that 1.2M is taxed at cap gains rate.

Wrong!

The 200k of depreciation you have written off would be charged at the recapture rate of 25%.

Now, where it really starts to count is when you sell a property and your gain is less than your depreciation write off.

Let's say I sell a building for a gain of 200K and I have written 500K off in depreciation.

This means I would not be taxed at the capital gains rate but rather the entire gain would be taxed at the recapture rate.

Ouch!

The only scenario this does not apply is if there is no gain on your property.

The last scenario happens when people hold for a long time and don't realize they are lowering their basis.

Then they go to sell they end up paying a significant premium in taxes.

Conclusion:

Please consult a tax professional before you sell and before you buy your building.

You will need some help in calculating your cost basis if you're new.

Please like this tweet to help spread awareness and save some people money.