Tax Basis - What It Is & How To Calculate It

By Austin Bowlin, CPA

Investment real estate is far from static, there are many factors that change during the ownership period. Tenants, lease rates, and property values are a few of the most dynamic elements – all change regularly and are crucial to monitor if the property is going to be effectively managed. As of late, laws and regulations have also changed at a rapid pace. Next comes the physical property condition. Barring a major catastrophic event, property condition tends to change at a slower pace, but still requires active maintenance so that a small problem does not become significant and costly - such as a clogged drain that backs up and causes significant water damage if not discovered soon enough. 

When we meet with owners regarding the transition options they have available to them, they generally have a good pulse on their tenants and physical property condition. However, one factor that is often overlooked is what their tax liability would be were they to sell their property. When considering a transition strategy, understanding the potential tax consequences is a major piece of the puzzle. Taxes may seem overly complicated (they are) and inaccessible (they can be), but calculating an approximate tax basis of your property can be done with a few key pieces of information. 

The term tax basis refers to the amount that will be subtracted from an eventual sales price to determine the taxable gain. Once the taxable gain is determined, it is generally divided into two categories. The first is the gain attributed to “Depreciation Recapture” – taxed at a current rate of 25%. The second is the gain attributed to appreciation beyond the original purchase price – taxed first at the owner’s “Long Term Capital Gains” bracket (currently either 15% or 20%) and possibly taxed at an additional 3.8% for the Net Investment Income Tax (also referred to as “Obamacare Tax”) depending on the owner’s investment income for the year. Owners may have “Loss Carryforwards” that help mitigate these tax consequences. It is important to note that a sale of property can also impact other taxes such as the tax on the sale of stocks or bonds and the tax on ordinary income in the year of property sale.

Knowing the tax basis of a property is an important step in assessing the options an owner has available to them. Owners with large tax liabilities should not feel limited if they want to transition their assets to take advantage of high valuations or lifestyle changes.  We regularly develop strategies for owners looking to unlock liquidity in their property and defer all their taxes. To assist owners in understanding the tax piece, we have worked with one of our preferred CPA firms, Hutchinson & Walter, to create a simple and effective template for owners to arrive at their approximate tax liability. If you are interested in accessing this tool, please email me at: AABowlin@RE-Transition.com

**This article was published in the December 2017 - RHAWA "Current" the monthly publication of the Washington Rental Housing Association.

Please note this article is for informational purposes only and does not constitute tax or legal advice. Your personal advisor should be consulted when making any tax or legal decisions.