How is the real estate market? On my corpse – the willits news
When I see people, especially the elderly, selling their real estate to be able to give the income to their children, it makes me sad because I know that by selling they inadvertently give a large part of their money to the Uncle Sam. If you own property, it is best to pass it on to your children. Let them sell it after you leave.
For tax purposes, real estate value is based on the acquisition cost of the property plus capital improvements minus depreciation. This is called the tax base. Usually, when ownership changes hands, the tax base is reassessed and if the value increases (as it almost always does), Uncle Sam expects his share in the form of capital gains tax.
For information, the tax base is divided between the raw land and any improvements (structures, landscaping, etc.). Because the raw land is not depreciable, it is in the owner’s interest to ensure that the land / improvement distribution is favorable: that the value of the land is low and that the improvement value is high. (You can read my column on Land v. Improvements for more on this.)
One of the ways to avoid paying capital gains tax is to transfer your property to a child or spouse upon your death. For income tax purposes, the property’s tax base is increased to the current market value, but your beneficiaries do not have to pay capital gains tax. For example, if you bought investment property for $ 150,000 20 years ago and amortized $ 100,000, the remaining base would be $ 50,000. If you then sold the property for $ 700,000, your profit of $ 650,000 would be subject to capital gains tax of approximately $ 215,000.
If, instead, you retained the property and left it to your children, upon your death their new tax base would be the fair market value of $ 700,000. They could then sell the property for $ 700,000 and pay no capital gains tax.
Here is another example. I own a house that I bought in 1973 for $ 15,000, which has since depreciated to $ 5,000. Its current market value is $ 350,000. If I sold it today, I would pay capital gains tax on $ 345,000 of profit, or about $ 115,000. The kicker is that I have refinanced the property several times and I currently owe $ 260,000 on it. If I sold the property for its current market value, I would have to pay capital gains tax plus salvage tax plus California income tax, which would leave me with $ 235,000 in cash less the 260,000. $ I owe on the mortgage, having to pay $ 25,000 more in taxes than I would get from the sale.
If, on the other hand, I kick the bucket tomorrow and my kids decide to sell, they’ll make $ 120,000. Please note, this example is based on today’s tax law, which is currently under negotiation. If the Biden administration is successful, things could change dramatically and your children would inherit your tax liability.
I’m sharing these examples to pique your interest. I do not give tax advice under any circumstances. Your investment decisions should be made in consultation with your tax accountant or other qualified financial planner.
If you have any questions about property management or real estate, please contact me at [email protected] or call (707) 462-4000. If you have an idea for a future column, please share it with me and if I use it I will send you a $ 25 gift certificate to Schat’s Bakery. To view previous articles, visit www.selzerrealty.com and click on “How’s the Market”.
Dick Selzer is a real estate broker who has worked in the field for over 45 years.