According to the Census Bureau, our country has nearly 116M housing units for a population of 330M men, women, and children. Sixty percent of the housing units are single-family detached homes.
The National Association of Home Builders states that roughly 7M of the housing units (about 6%) are second homes or vacation homes not available to rent.
The Census Bureau calculates there are 20M rental properties in the U.S., owned by 14.3M individual investors. According to www.AirDNA.co, there are 1.1M short-term rentals.
So, there are over 28M properties out of 116M that are either vacation homes, second homes or investment properties of some type.
The Colorado Association of Realtors reports that the number of second home sales has jumped 44% since the beginning of Covid in March 2020. So, whether you own a vacation home, second home, rental home, or short-term rental condo, you own real estate subject to capital gains tax when you sell.
Many sellers of investment properties take advantage of the Sec. 1031 tax deferred exchange option, which allows the property owner to put your full proceeds, pre-tax, to work.
Doing a 1031 exchange of real estate requires what’s called a “qualified intermediary” (or QI) and not the title company conducting the closing to hold your proceeds until you reinvest them, and the IRS allows 45 days to identify and 180 days to close on the replacement property. Sellers cannot “touch” the proceeds from the sale of your relinquished property. The QI must work with the title company to facilitate transfer of the proceeds to the new closing. If a qualifying replacement property cannot be closed within 180 days, that opportunity is lost and the gain will be taxable.
Unless the investment property is inherited at your death, there will be a capital gains tax liability. For some, the gain has been so significant that perhaps it’s time to pay the tax and laugh all the way to the bank with the remainder. Note: You cannot use the 1031 tax deferral strategy to sell or purchase a primary residence.
There are capital gains tax calculators online. Here’s one: https://smartasset.com/investing/capital-gains-tax-calculator
Here’s the IRS’s Fact Sheet for 1031 Exchanges: www.irs.gov/pub/irs-news/fs-08-18.pdf
To determine your tax exposure, start with the original purchase price. What did you pay for the property when you bought it? Second, add up all the money you put into capital improvements of the property. Then subtract depreciation which you took on your tax returns. The IRS considers investment real estate’s “useful life” to be 27.5 years. The cost basis of the property is the amount you paid, plus the cost of selling it – commissions, settlement fees, and closing costs, minus the depreciation taken.
An agent in our office calculated the following numbers for a deal he is doing and roughly calculated the net gain. His seller’s unit was purchased in 2016 for $275,000, netted the owner $10,000 per year in passive income, enjoying a 61% profit in just six years, after tax. The lucky owner paid the tax man and was left with roughly $377,000 in cash after everything was deducted. Discuss your particular situation with your CPA if you have one, and, if not, I can recommend a local firm. These figures are round numbers and for the purposes of this article.
I believe in paying taxes. It is pothole season and street crews are at work. Fireman are on call and the police are vigilant. Our national defense is strong, and we live in the most prosperous nation in the world where wealth can be created simply from smart investing. Be proud, as I am, to pay your taxes, for you made a lot of money in a beautiful place called Colorado.
Austin Pottorff, who deals more than I do with investors, helped with the research for this article. He has two development sites listed at this time. See them at www.GoldenDevelopmentSite.info and at www.LakewoodDevelopmentSite.info.
Jim Smith's Blog 