Some Types of Taxes When Selling Real Estate, and a 1031 Exchange May Save Money

There are certain differences between owner-occupied property and investor property (non-owner occupied) when it comes to selling--and buying, but here we are concerned more with selling.

Some owners who have rented out their residences and moved on to another location are surprised to find out when it comes time to sell that they may have lost their capital gains exclusion ($250,000, or $500,000 for married owners). On top of that, they may be paying the State of California 3-1/3% withholding tax upfront at the close of escrow.  Additionally, if you took depreciation on an income property you now own as an investor, you will have additional reckoning at tax time.  Please see IRS Publication 523 for specific information.

Depreciation is a method for matching the costs of acquiring property over the properties’ estimated
economic life.  The IRS requires that most properties be depreciated via the ‘straight-line’ depreciation method.  Using the straight-line method, residential income properties are depreciated over 27.5 years.  Commercial properties are depreciated over 39 years.

Depreciation Calculations
Land is not depreciable.  In order to properly calculate depreciation, the value of land must be excluded. For example, a $1MM duplex with land worth $300,000 has $700,000 worth of depreciable real estate.  Using the straight-line depreciation method, the annual depreciation amount is approximately $25,500 ($700,000/27.5)  NOTE: The IRS will typically not challenge the assessment of the land value if it is reasonable. A tax advisor, attorney or real estate agent should be able to provide guidance for what is reasonable based on the location and type of land.

Depreciation Benefits
Depreciation is an ‘intangible expense’ that will reduce the reportable taxable income from the property, and means less tax to the IRS.
Here’s how it works:
The yearly rental income from the example duplex is $36,000. At the end of the year, this will have to
be reported to the IRS. However, the IRS does not tax the entire $36,000. The taxable income from the property is calculated as follows:

• Rental Income
• (Expenses)
• (Depreciation)
• Taxable Rental Income

If the expenses of operating and managing the duplex are $5,000 for the year, the taxable rental
income is calculated as follows:

• Rental Income $36,000
• (Expenses) ($5,000)
• (Depreciation) ($25,500)
• Taxable Rental Income $5,500

NOTE: Please always seek the guidance of a tax advisor. Capital gains may or may not apply depending on how long you lived in the property, and depreciation items may be calculated on different schedules. To completely avoid last minute upsets and lose your deal, it's important to obtain your information before you sell--I once represented a buyer on a very nice fourplex where the seller finally obtained tax guidance after we opened escrow, only to be shocked by how much recapture tax had to be paid to the IRS since the property had been owned long enough to be fully depreciated.  The seller cancelled escrow, much to the buyer's disappointment.

Depreciation Tax
Upon the sale of an investment property, the IRS requires the payment of a depreciation re
tax, which means you have to "pay back" the money you were entitled to take previously. The tax rate is currently set at 25%. In the example above, if the duplex was owned for 10 years, the entire depreciation taken on the property would amount to $255,000 ($25,500 x 10).  The IRS requires a recapture tax on that entire amount. Hence, the sale of the duplex will result in a $63,750 depreciation recapture tax (255,000 x 25%). This is in addition to state and federal capital gains taxes. The depreciation recapture tax as well as any associated capital gains taxes can be deferred in full via a 1031 Exchange.

Conclusion
Of all the benefits of owning real estate, depreciation may be one of the most important. The tax advantage depreciation offers is powerful. The IRS will always assume that depreciation is taken and
will hold an investor liable for the deprecation recapture tax – even if the investor failed to take advantage of the depreciation. Bottom line: make sure you are taking advantage of this powerful tool.
Thanks to Asset Exchange Company for this sample.

Prices in Long Beach, Lakewood, Cerritos, Signal Hill

Home prices continue to rise in Los Angeles and Orange Counties, 6% to June of this year from June of last year according to the Los Angeles Times.  In the four cities below, the average days on market for a single family home in August ranges from 41 days (Lakewood) to 67 days (Signal Hill). Long Beach had total closings of 193 (not surprising since it's the largest city of the four), Signal Hill had 6 closed sales, Cerritos had 26 sales, and Lakewood had 72 sales.

Even though the National Association of Realtors® reported that sales in July were the highest since 2007, Long Beach and Cerritos sales volume decreased somewhat in August.

Housing inventory is still low, although a recent daily trend for the local market shows a higher number of new listings in the MLS than closed sales. For August, however, each of the four cities below shows a decrease in inventory supply from the prior month: 1.6 months (Lakewood) being the lowest, and 3.7 months (Signal Hill) being the highest. Long Beach had 2.2 months supply in August. The traditional norm for a normal market supply has been 6 months.  This is a long term trend: Prices go up while inventory remains low.

Condo prices, which are typically lower than single family home prices, also increased from the prior month: average prices in Lakewood -- $485,000; Signal Hill -- $379,000; Long Beach -- $362,000; Cerritos -- $392,000; all prices represent increases from prior month range from 2% (Signal Hill) to 60% (Lakewood).

Don't Overprice Your Home's Asking Price

When a willing buyer and a willing seller complete a home sale, they have just announced to the world what the value of that property is.  That home may now be used as a marker for other similar home sales, based on other factors:

Location - proximity to community attributes such as parks, schools, and job market usually has more desirability to the buyer.
Size - Larger homes and larger lots may sell for more, and comparing a home to one that is much larger or much smaller could lead to the wrong pricing.  A buyer's lender may have very specific criteria on size when it comes time for the appraisal.
Bedrooms and bathrooms - The most common request from buyers today is for a three-bedroom, two-bath home; families today want and expect more privacy than in prior eras. And, the difference between a two-bedroom vs. a three-bedroom home may be critical for the buyer.
Features - Luxury sells, and homes with newer flooring, newer counters and cabinets are perceived as more luxurious and appealing. Some features such as spas and pools may not be worth extra to the buyer, these are often market-led factors. Newer landscaping may be a comparison item depending on the area.
Condition - A newer home that is well-maintained retains more of its original value, as do updated older homes. Homes with deferred maintenance sell for less.
Appeal - A home that looks inviting on both the exterior and the interior may be able to compensate somewhat for a less desirable location, or some other condition the seller has no control over.

If your house looks like this . . .

Too often sellers based an asking price on their own perceived value, or because they are comparing their property to a recent sale that is not completely comparable to theirs. Understanding how the buyer views the property, using the proper sale comparables most likely to be used by an appraiser, and seeing how their property stacks up against the immediate competition in the local market are important tools for seller objectivity.

It cannot be compared to this.

The public online valuation systems may be very accessible and offer quick valuations, but the homeowner should keep in mind that these systems do not use software that can "see" the home the way the buyer or your REALTOR does.  They use the public tax records, and may include properties inappropriate for yours.  As an example, 9 recently sold SFRs or condo properties in the Long Beach 90803 zip code between February 25th and August 4th, 2015 varied as much as 68% between the actual sales price and the online value estimate by a popular website company.  (Many real estate data sources within the industry do use AVMs, but some are "closer" to value than others.)  In this particular instance with the 9 properties, 6 of the properties were overestimated in value, and 3 were underestimated.  Two of the underestimated were within 1.8% of the actual selling price, which is a realistic market difference, while the third underestimated value was 17% less, which is far outside of the average  list-to-sell price.  The condo that was overestimated in value by 68% at $572,000 actually sold at $339,000.  Other estimates ranged between 7% to 41% over selling price. 

Speaking of estimates, the value of an experienced real estate professional cannot be underestimated. A good market opinion and strategy can earn you more money at the close, and save unnecessary time on the market.  Please contact me, a professional with 20 years' of experience!