The real estate is the real big issue here. Most of the time if you have held income producing real estate long enough then the cost basis is reduced to zero.

If you are investing in real estate then you more than likely will keep leverage (loans) on the property so you can continue to grow a portfolio by reallocating your equity in property elsewhere.

Eventually there is no way to sell the property because the basis can actually be negative and the net proceeds after the loan is paid off will be used almost exclusively for taxes. In some cases the tax is more than the proceeds.

This is from an article I found that shows the point. For example your dad dies and leaves you his real estate. It has a fair market value of $1,000,000 and is subject to a mortgage of $800,000. Thus, the equity is worth $200,000. Also assume the property has a cost basis of $50,000. If the property were sold, the gain subject to income tax would be $950,000 resulting in income tax of approximately $237,000 assuming a combined state and Federal tax rate of 25%. Under that scenario, the tax would be $37,500 greater than the equity. To dispose of that property, the owner would have to come "out of pocket" to pay the taxes. If it were possible to transfer that property to heirs, absent a basis step up, you would be transferring a net liability after taking into account income taxes. Contrast this with the estate tax liability (assuming a 50% rate). The estate tax would be $100,000, $137,000 less than the income tax liability inherent in the asset.

The only option left is for the property to be passed on to heirs at a stepped up basis.

1 Jump to Post ...

Report Post Jump to Post

Posted by LSUFanHouston

NOLA

Member since Jul 2009

37857 posts

Posted on 1/21/15 at 4:27 pm to Maderan

quote:
basis can actually be negative

Basis can never go below zero.

As for the example you gave... think about economically.

There can only be a few reasons I can think of to have that big of a difference between debt and basis:

1) At least one 1031 exchange has occured, in which case, the taxpayer upon sale is really recognizing the gain on more than one property

2) A relatively recent loan was taken against the property, maybe in a refinance, and the proceeds were not capitalized back in the property, and instead where used on other property.

3) Same as two, but instead of using it on another property, it was used on the subject property, but ordinary expense deductions were taken (maybe a bunch of repairs written off).

The owner may be coming out of pocket to pay the tax, but the owner has enjoyed greater tax deductions over the years. Truly, the time to pay the piper has come.

1 Jump to Post ...

Report Post Jump to Post

Money Talk - Replies to Post

Return To Board

Page 1

Return To Board