Selling: timing, costs and the tax bill

Investors spend enormous effort on acquisition and comparatively little on disposition, which is where the accumulated gain is either realized efficiently or handed over.

The costs of selling

Larger than most people budget.

Agent commissions, historically in the range of five to six percent split between sides, though commission practices have been changing following legal settlements and are increasingly negotiable.

Seller-paid closing costs, which vary by jurisdiction and custom.

Transfer taxes, which in some jurisdictions are substantial.

Title and escrow charges where customary for the seller.

Attorney fees where applicable.

Repairs negotiated after inspection, which almost always occur.

Prepayment penalties on the retired loan, which on commercial debt with yield maintenance or defeasance can be very large.

Carrying costs during the marketing and closing period.

Total transaction cost commonly lands somewhere around seven to ten percent of sale price, which is why frequent trading destroys returns.

The tax on sale

Several components, and the recapture piece surprises people.

Capital gain on the amount by which the sale price exceeds the adjusted basis, taxed at long-term rates for property held more than a year.

Depreciation recapture, on the portion of gain attributable to prior depreciation on real property, generally taxed at a rate of up to twenty-five percent rather than at capital gains rates.

This applies to depreciation allowed or allowable — you cannot avoid it by not having claimed it.

Net investment income tax, which may apply to gain for taxpayers above certain income thresholds.

State income tax, which varies substantially and which in some states is significant.

The combined figure frequently surprises sellers who calculated only the federal long-term capital gains rate.

Calculating adjusted basis

The number that determines the gain, and the reason record-keeping matters over decades.

Original purchase price, plus capitalized closing costs, plus capital improvements, less accumulated depreciation, less any casualty losses claimed.

Every documented improvement reduces the taxable gain. Every undocumented one does not.

An owner who spent substantially on improvements over twenty years and can evidence only part of it pays tax on the difference.

Deferral options

Section 1031 exchange, covered elsewhere on this site, which defers gain where proceeds are reinvested in like-kind property subject to strict timing and structural rules.

Installment sale, where the seller provides financing and recognizes gain as payments are received.

Note that depreciation recapture generally cannot be deferred under installment treatment and is recognized in the year of sale, which can create a tax liability exceeding the cash received in that year.

Opportunity zone investment, which under specific rules permits deferral and potential partial exclusion where gain is reinvested in a qualified fund within a defined period. The rules are technical and the program's terms have specific dates attached.

Holding until death, where under current law heirs generally receive a stepped-up basis, eliminating the embedded gain.

Each of these has conditions, costs and risks. None should be pursued without professional advice, and none should drive an investment decision that otherwise does not make sense.

Suspended passive losses

The offsetting item people forget.

On a fully taxable disposition of the entire interest in an activity, previously suspended passive losses are generally released.

An investor with years of suspended losses may find a substantial deduction available in the year of sale, materially reducing the net tax.

This is worth calculating before assuming the tax bill is prohibitive, and it is worth considering in the sequencing of multiple dispositions.

Timing the sale

Beyond market conditions, several practical considerations.

Hold past one year for long-term capital gains treatment.

Consider the tax year. Closing in January rather than December defers the tax liability by a full year, which is worth something.

Consider your income in the year of sale. Rates are income-dependent, and a year with lower ordinary income may produce a better outcome.

Consider the leasing season. A property sold with units vacant in a slow season is worth less than the same property fully occupied.

Address deferred capital first, or price for it. Buyers discount heavily for a roof at end of life, frequently by more than the replacement cost.

Preparing the property

Investment property sells on numbers, so prepare the numbers.

Clean, well-organized operating statements. A verified rent roll. Copies of all leases. Service contracts. A capital improvement schedule showing what has been done. Utility histories. Tax and insurance documentation.

A well-documented property attracts more buyers and fewer retrades. A property with disorganized records invites suspicion and price reductions.

And address the obvious physical items. Buyers extrapolate from what they can see, and visible neglect implies invisible neglect.

The question worth asking first

Before selling, calculate the net proceeds after all costs and all taxes, and compare against what the property produces if held.

A property yielding a modest return on its current equity may still be worth keeping once the transaction costs and tax of exiting are counted, since redeploying the net proceeds starts from a smaller base.

That calculation changes a good number of selling decisions.

General information about United States tax concepts, not tax or legal advice. Rules are technical and subject to change. Consult a qualified tax professional before any disposition.