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Sale of rental home after taking out equity

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Level 3

My client wants to take out $100,000 equity out of his rental home and then sell it, thereby having no capital gain for tax purpose.

Will this action affect him negatively in any way?

He owed $110,000 and after taking out another $100,000 he now owes $210,000 but will be able to sell it for $230,000. After all expenses of sale he has no capital gain, but the $100,000 equity loan was not used for building, upgrading or anything else to do with the house expense.

My concern is will IRS impose any kind of tax on the $100,000 he took out.

Any help would be appreciated.

 

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7 Replies 7
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Level 15

No. But the interest on the new loan is probably not deductible.


ex-AllStar
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Level 15

Removing equity via a refinance does NOT provide additional basis; it does NOT reduce the gain.

And as Susan said, if the cash withdrawn isn't used for improvements to the property, the interest is (with few exceptions) no longer deductible.

Former Chump... umm.... AllStar.
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Level 15

Basis = original cost of the property (or FMV if lower when converted to rental) plus improvements minus depreciation.

My mind reading skills are not as good as Anna's.


ex-AllStar
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Level 15

@sjrcpa 

Maybe for today anyway. 

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Level 10

Payment of debt does not reduce the gain. See others for more explanations.

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Level 15
Level 15

Borrowing against it wouldnt reduce his taxable gain at all.

Youre still left with purchase price plus improvements vs. sales price less expenses and then youve got the depreciation to recapture as well.

What you owe on the mortgage doesnt factor into the taxability of the sale.


♪♫•*¨*•.¸¸♥Lisa♥¸¸.•*¨*•♫♪
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Level 12

You and your client are confusing Equity (or worth minus loan balance) and Gain.

Equity = your ownership position. The more in debt you are against the value of the property, the less Equity you have in it. That means it is more leveraged than if there was no debt on it. That doesn't have anything to do with Basis or Gain. You could buy something for cash or fully as debt, and your Basis is the same. Your Equity is different, though.

sjrcpa tells you how to understand Basis.

Gain (simplified) is:

Sales Price minus Basis (and further reduction for allowed costs of making that sale happen, such as commissions paid) = Gain or Loss.

It seems both you and your client need some better guidance on this.

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