# How to Calculate Capital Gains Tax on the Sale of Investment Property

Multifamily Investment Sales Broker at Marcus & Millichap
P: 630.570.2246

When you sell an investment property, all of your profits are subject to either capital gains tax or depreciation recapture tax, which is a special type of capital gains tax. Your tax gets calculated on the difference between your cost basis and your selling price. Any debt that you owe, such as the balance on your mortgage, will not affect your capital gains liability.

Your cost basis isn’t just the purchase price of your investment property. The initial cost is what you actually paid at the closing, including your closing costs.

For example, if you bought a small apartment building for \$1 million and paid \$1,500 in title fees, \$5,000 in attorney’s fees, \$2,000 in miscellaneous fees, and \$8,000 in inspection fees, your actual cost would be \$1.0165 million.

To that cost, add the cost of any improvements you made to the property. Improvements are anything that changes your property’s use, increases its value, or extends its useful life. Taking the apartment building as an example, a \$50,000 roof and \$115,000 in kitchen and bathroom renovations would count as improvements and increase your cost basis to \$1.1815 million.

## Depreciation and Basis

While you own your investment property, the tax code lets you claim a small portion of its cost basis every year as a depreciation write-off. Depreciation is an accounting tool that simulates the decline in value that accompanies the gradual deterioration of buildings (although in recent years, almost all property has actually gained value over time).

When you sell it for more than the depreciated value, the IRS will want you to return a portion of the money that you saved by claiming depreciation. To properly calculate your capital gains liability, you will need to total all of the depreciation that you were legally entitled to claim, whether or not you actually claimed it.

## Calculating Tax Liability

You owe capital gains taxes on the difference between your adjusted cost basis and your net selling price. If you, for example, sell your apartment building for \$1.95 million and pay \$105,000 in commission and \$8,700 in closing costs, your net selling price is \$1.8363 million. Subtracting your \$1.1815 million cost basis gives you a taxable capital gain of \$654,800.

In addition, if you sell for a profit, you will have to pay depreciation recapture taxes on all of your accumulated depreciation. If you claimed \$320,000 in depreciation while you owned your building, you need to pay depreciation recapture tax on all of the \$320,000.

If you sell for a loss, you will pay recapture tax on the difference between your net selling price and your depreciated basis. For example, if you sold the building for \$925,000, you would have a capital loss, but since your depreciated basis would be \$861,500 (\$1.1815 million minus \$320,000), you would pay recapture tax on the \$63,500 difference.

## Federal Tax Rates

Capital gains on assets that you hold for at least one year are considered long-term gains. For the tax year 2019:

• Taxpayers filing single pay 0 percent capital gains tax (income up to \$39,375), 15 percent capital gains tax (income \$39,376 to \$434,550) and 20 percent capital gains tax (income more than \$434,550).
• Taxpayers filing married filing jointly pay 0 percent capital gains tax (income up to \$78,750), 15 percent capital gains tax (income \$78,751 to \$488,850) and 20 percent capital gains tax (income more than \$488,850).
• Taxpayers filing head of household pay 0 percent capital gains tax (income up to \$52,750), 15 percent capital gains tax (income \$52,751 to \$461,700) and 20 percent capital gains tax (income more than \$461,700).
• Taxpayers filing married filing separately pay 0 percent capital gains tax (income up to \$39,375), 15 percent capital gains tax (income \$39,376 to \$244,425) and 20 percent capital gains tax (income more than \$244,425).

Short-term gains are taxed at your marginal income tax rate. In addition, depreciation recapture is taxed at 25 percent.

You may also be subject to a 3.8 percent Medicare surtax if your income exceeds \$200,000 if you are single or \$250,000 if you are married. These rates went into effect for the 2013 tax year and will not change without new laws being passed. It’s always a good idea to verify these rates with the IRS or your accountant.

## Loans and Gains

What you pay off on your loan isn’t tax-deductible. However, you can amortize many of the costs of getting your loan over its life.

For example, if you pay \$12,000 to take out a mortgage with a 10-year term, you can write off \$1,200 per year. If you were to sell your property after only three years, you’d have \$8,400 in remaining loan fees that you hadn’t claimed. You would be able to add those remaining fees to your cost basis, reducing your gain when you sold your property.

## How to reduce or avoid capital gains taxes

Capital gains taxes can take a significant bite out of your profits. But there are ways to reduce or even avoid these taxes on the proceeds from the sale. Here are three strategies.

The easiest way to limit or avoid the capital gains tax is to convert your investment property to your primary residence. The reason? If you sell a primary residence, you don’t have to pay taxes on the entire gain. That’s because IRS Section 121  lets you exclude up to:

• \$250,000 of capital gains on real estate if you’re a single filer.
• \$500,000 of capital gains on real estate if you’re married and filing jointly.

To count as your primary residence, you must own and live in the house for at least two of the five years immediately preceding the sale. Say, for example, that you bought an investment property in 2010, and in 2015 you converted it to your primary residence. In other words, you moved in and called it home. In 2019, you can then sell the property as a primary residence because you lived in it (and owned it) for at least two out of the previous five years.

### 2. Offset gains with losses

Another way to lower your tax liability when you sell investment property is to pair the gain from the sale with losses from your other investments. This strategy is called tax-loss harvesting.

The IRS aggregates your gains and losses for the year. So even if you sell your investment property at a profit, you can offset those gains by losses you had in, say, the stock market. For example, if you had \$53,000 in capital gains from selling your investment property, and in the same tax year had \$50,000 in losses from bad stock investment, your capital gains would be limited to just \$3,000.

One caveat to know: The tax code requires that short-term and long-term losses get used first to offset gains of the same type. But if your short-term losses exceed your short-term gains, you can apply the excess short-term losses to any long-term gains. Likewise, if your long-term losses are greater than your long-term gains, you can apply the excess long-term losses to any short-term gains.

### 3. Take advantage of a Section 1031 exchange

If you want to sell an investment property — but don’t need to cash out just yet — you can defer paying capital gains taxes by doing a like-kind exchange.

Section 1031 is a provision of the U.S. tax code that lets you sell an investment property (called the “relinquished property”), buy a “like-kind” property, and defer paying taxes. This process is called a  1031 Exchange, a Starker Exchange, or a like-kind exchange. In most cases, a  Qualified Intermediary (QI)  acts as a third-party facilitator to ensure the process goes smoothly.

To qualify as like-kind property, it must be real property (i.e., real estate) that you’ve held for productive use in a trade for business or for an investment. Personal residences don’t count. Neither do vacation homes.

There are strict time limits for 1031 exchanges. After you sell your investment property, you have 45 days to identify up to three like-kind exchange properties.

After that, you must close on the new property within 180 days of selling your investment property, or before your tax return is due for the year you sold the property — whichever comes first. If you don’t meet these deadlines, the transaction won’t count as a 1031 exchange and any capital gains taxes will become due.

Capital gains taxes can take a big bite out of your profits when it comes time to sell your investment property. Fortunately, there are ways to lower and defer these taxes. Taxes are complicated and rules change, so it’s always recommended that you work with a qualified tax specialist to make sure you receive the most favorable tax treatment possible.

Sources: https://finance.zacks.com/calculate-capital-gains-sale-investment-property-mortgage-owed-9381.html | https://www.fool.com/millionacres/taxes/capital-gains/how-capital-gains-tax-investment-property-work/

# Single Tenant Drug Store Sector Cap Rates Increase

Multifamily Investment Sales Broker at Marcus & Millichap
P: 630.570.2246

#### Cap rates for Rite Aid and Walgreens properties experienced cap rate increases of 19 and 15 basis points respectively.

National asking cap rates in the single-tenant drug store sector increased to 6.4% in the third quarter, according to The Boulder Group’s Net Lease Drug Store Report. This represented a 17 basis point increase when compared to the prior year.

“The drug store sector, hasn’t been developed a lot in the last few years,” states Randy Blankstein, president of the Boulder Group. “They’ve been renegotiating leases. A lot of the stuff that has traded was older because people see the cap rates come down and want to take advantage of it.

In the third quarter, the net lease drug store sector was priced at a 33 basis point discount to the net lease retail sector. The increase in cap rates for the drug store sector was driven by a shorter average remaining lease term, which dropped to 10 years in the third quarter.

If you group drug stores with similar lease terms together, cap rates are down slightly, according to Blankstein. “Among the ones that have traded, cap rates have gone up because shorter-term [leases] can trade. People see the cap rates going down and they think this is a good time to sell.”

Cap rates for Rite Aid and Walgreens properties rose 19 and 15 basis points respectively, while single-tenant CVS properties experienced a 10 basis point decrease. These tenants remained open due to their essential status and continued to pay rent on time, according to the Boulder Group.

“Rite Aid is not industrial grade and has been through various cycles and spinoffs,” Blankstein says. “Walgreen and CVS are investment grade and sell more similarly. Between Walgreens and CVS, CVS sells a little better because it’s a much bigger company. Walgreens took a lot of stores from Rite Aid and a lot of those stores have overlap with their existing stores. Walgreens has some stores that won’t be renewed in the future so a lot of people think CVS is the better.”

Through Q3 of 2019, the Boulder Group tracked 363 single-tenant drug store sector trades for \$1.6 billion. Through Q3 2020, 496 transactions sold for \$2.1 billion, which was a 31% increase.

“We’re up 30% volume this year, which probably means we borrowed some from next year and supply will be less next year,” states Blankstein. “Transactions would probably go down because of less supply, demand will be the same. So you could argue that supply goes down, demand remains the same, and cap rates continue to go lower for equal lease terms.”

The supply of long-term leased properties is decreasing. In 2019, leases with more than 15 years remaining on their primary term made up approximately 25% of the market. In 2020, this segment has decreased to approximately 15% of the market.

“Anytime there’s a lack of new construction, it’s going to trade less because people are always looking for fresh lease term,” says Blankstein.

“Transaction velocity for the remainder of 2020 should continue to favor essential retailers with drug stores being a beneficiary of the increased demand,” Blankstein says.

Source: GlobeSt By Les Shaver | November 02, 2020 at 06:30 AM

# 1031 Exchange Buyers Drive Sales

Multifamily Investment Sales Broker at Marcus & Millichap
P: 630.570.2246

In April 1031 exchange buyers were given an extension. The Internal Revenue Service issued guidance that said anyone who closed on a sale on or after April 1 would be granted an extension until July 15 to identify their replacement properties.

When that happened, Chris Pappas, associate director with Marcus & Millichap’s Net Lease Division, thinks the typical timeline for investing in 1031 exchange was relaxed.

“They didn’t have that urgency to move as quickly,” Pappas says. “Then, once they began to understand the market post-lockdown, then they started moving and closing transactions.”

As the July 15 deadline approached, 1031 investors started identifying deals. That showed up in June’s transaction number, according to the NNN Market Intelligence Report for June 2020 from Pappas. In the month, single-tenant sales jumped 67 percent compared to May. In all, 271 transactions were completed in June compared to 162 in May.

Going forward, Pappas wonders how much 1031 capital will be left. He says that 1031 exchange buyers only need to identify the property they’re buying by July 15. They still have 135 days to close.

With due diligence taking 30 days and closing taking 30 days, Pappas thinks most 1031 capital will be out of the market 60 days after July 15 (September 13). “Generally. you don’t see people taking that entire timeline to close their transactions,” he says. “They typically close well in advance of the 180 total days.”

Right now, Pappas says there is still a critical mass of people that are processing their transactions. But once September arrives, there could be a lull. Going forward, he thinks investors should be cautious until the exchange buyer pool benefitting from the July 15, 1031 extensions are entirely removed from the market.

In addition to an increase in transactions, June also saw the resurgence of activity in Florida. After tallying \$18.7 million in May in May, dollar volume rebounded 267 percent to \$88 million in June, according to the NNN Market Intelligence Report for June 2020. June’s total transaction velocity fell just short of April’s 280 transactions.

Overall, the South attracted 40 percent of all investment. The Texas/Oklahoma and West regions dropped in dollar volume for the second straight month, while the Mountain region jumped from \$52 million in May to \$120 million in June.

Despite those increases, COVID-19 continues to weigh on the sector. “With respect to demand for net lease real estate, there has also been a huge decrease in transactions across all product types nationally,” Pappas says.

Investors continue to prefer quick-service restaurants (69 transactions), dollar stores (61 transactions), and pharmacies (45 transactions). Those properties made up 64 percent of all June transactions. Pharmacies accounted for 29 percent of total dollar volume in single-tenant net lease, while quick-service restaurants came in second at 19 percent of dollar volume in the sector.

“The market also experienced an uptick in sales tenanted by automobile and gas/convenience tenants and a decline in bank tenanted assets,” according to the NNN Market Intelligence Report for June 2020.

Source: GlobeSt By Les Shaver | July 21, 2020 at 02:51 PM

# Webcast Replay – Using a 1031 Exchange to Maximize Returns

Multifamily Investment Sales Broker at Marcus & Millichap
P: 630.570.2246

# Live Webinar Wed – Using a 1031 Exchange to Maximize Returns

Multifamily Investment Sales Broker at Marcus & Millichap
P: 630.570.2246

# Unprecedented Opportunity for Owners to List Now

Multifamily Investment Sales Broker at Marcus & Millichap
P: 630.570.2246

COVID -19 has disrupted the normal market equilibrium of supply and demand, creating a unique window of opportunity for attracting exchange-motivated capital.

Despite commentary suggesting a stalled transactional market, Marcus & Millichap has seen near-record levels of closed transactions in 2020. As the 1031 exchange market leader, we know that nearly 40% of these sellers will become buyers.

Moreover, the health crisis has slowed new listings, further amplifying the opportunity for sellers to capitalize on the imbalance in place today.

Marcus & Millichap has the industry’s largest sales force of commercial real estate advisors and long-standing relationships with private clients, the primary source for 1031 exchange capital. Contact us today to take advantage of the small window for tapping this unique market opportunity.

Multifamily Investment Sales Broker at Marcus & Millichap
P: 630.570.2246

With so many exchanges facing the same deadline, there is very real potential for unintended consequences.

As a result of the COVID-19 pandemic, the IRS issued Notice 2020-23, which provided a multitude of tax extensions, including 1031 like-kind exchange deadlines for some investors.

While the extensions were provided for good reason, there may be unintended consequences if eligible investors all wait to pull the trigger on their exchanges near or at the time of the deadline. Here’s a look at how that could happen.

The typical investor in a 1031 exchange has 45 days from the sale date of the original property to identify a replacement property, and 180 days from the sale date to complete the purchase of a replacement property. With the IRS’s new notice, the 45-day and the 180-day deadlines have been extended until July 15, 2020, for investors who originally had their 4th day or their 180th day fall between April 1, 2020, and July 15, 2020.

One example of how this could affect someone in a 1031 exchange would be if they had sold their property on April 3, 2020, in which case their 45th day would have been May 18, 2020. (They would have had to formally identify their replacement property by then.) Under the new guidelines, the same investor would have until July 15, 2020, to identify a replacement property.

More time is generally good, but if too many investors wait to effect their exchanges, the odds of unintended consequences are high. The possible outcomes? One may be that demand for quality exchangeable investment real estate exceeds the available supply in the first two weeks of July. If this happens, investors face fierce competition over replacement properties and could end up overpaying for choice assets.

Notably, many localities have seen a  significant drop in real estate listings since the outbreak of COVID-19, so the supply of available replacement properties is below normal.

Another consequence is that if an investor waits to purchase a replacement property, the investor may not have enough time to complete their transaction. I don’t think we have ever had a time in America where so many 1031 exchangers had the same deadline date.

A good option for many 1031 exchange investors facing deadline pressure may be co-investment products such as DSTs (Delaware Statutory Trusts) because the financing and due diligence are already in place by the sponsor and it’s possible to complete a purchase in three to five business days typically. So clearly, tight market or not, there are now highly viable investment options for 1031 replacement property buyers.

Bottom line, many 1031 exchange investors are rightly taking a reevaluation of the marketplace in the midst of the COVID-19 pandemic, but with so many 1031 exchangers in America facing the exact same deadline on July 15, there is very real potential for unintended consequences.

Source: National Real Estate Investor Alex Madden | Jun 02, 2020

# 1031 Exchanges: 10 Things to Know

Multifamily Investment Sales Broker at Marcus & Millichap
P: 630.570.2246