Computing gain or loss on the disposition of real property requires a thorough review of many items. Generally, gain or loss is calculated simply as proceeds less unadjusted tax basis. Determining the proper treatment of various items associated with the disposition can have significant impact on your income tax liability associated with the disposition.
Depending on the type of gain associated with the disposition of the property, multiple tax rates may apply. For example, gain may be taxed at capital gain rates (0%/15%/20%), ordinary income tax rates (as high as 39.6%), or depreciation recapture rate (25%), and if the disposition is considered investment property, the gain may also be subject to the 3.8% net investment income tax. Gain is also subject to state income taxes.
In addition to simply reviewing the fixed asset schedule to determine gain or loss, other items related to the property, the lender and the property's tenants must be examined. Loan fees may have been paid to the lender, which are generally required to be amortized over the life of the loan. Lease commissions may have been paid to secure tenants. These costs are required to be amortized over the life of the lease. At the sale date, these items may not be fully amortized. The early payoff of the debt may result in a prepayment penalty. Closing costs such as transfer taxes, legal fees and commissions are also very commonly associated with the sale.
Each of these costs must be considered to properly calculate your gain or loss on the disposition. Specific guidance requires some of these costs to be deducted in the year of the sale; and others are required to be added to your basis to determine gain or loss. Depending on your income tax rate, the tax difference can be as high as 25% (39.6-15) if certain items are not treated properly.
Your SD real estate industry professionals can help you navigate through the proper handling of these types of costs when disposing of real property, as well as discuss other possible strategies to defer gain for the disposition.