You've decided to go through the effort to sell your investment property: making repairs, dressing up the property to look stunning, marketing to a large number of prospective buyers, and negotiating offers. You waited an eternity for buyer financing to go through. Now you've closed the sale and are due a cash windfall. Congrats!
Don't spend your proceeds until you do these 4 things
Prepare to pay taxes
You'll receive a lump sum upon selling your property, which might make you feel flush with cash. Be careful not to spend more of it than you should, especially the amount you'll owe on your taxes. Work with a tax advisor to figure out how much to set aside and when to pay taxes. They will work with you to figure out how much of the proceeds is considered a gain.
Gain = Selling Price - Selling Expenses - Adjusted Cost Basis Adjusted Cost Basis = Purchase Price + Some Purchase Transaction Fees + Improvements - Depreciation
The two types of taxes you will face when selling an investment property are depreciation recapture and capital gains tax.
If you operated a rental property, it's likely that your tax advisor used a depreciation deduction to reduce your prior tax bills. Now the IRS wants it back. Any gain attributable to prior depreciation is taxed at a 25% recapture rate. The remainder is taxable under capital gains rules.
You may be eligible to deduct suspended losses if you operated a rental property at a loss in prior years. You may also be eligible for a primary residence exclusion if you lived in the property as a primary residence for two out of the last five years.
This means that to figure out all your taxes and maximize all available deductions, you'll want to gather all of the following records for your tax advisor:
Settlement statements from both the purchase and sale of the property
Form 1099-S, which you receive shortly after selling your property
Tax returns during the years you owned the property
Records of all improvements made to the property that add value, prolong its useful life, or adapt it to new uses
Holding expenses while the property was not a rental property
Selling expenses incurred, such as staging
Further reduce your taxes with tax loss harvesting
If at this point, you still have taxable capital gains, you may have an opportunity to further reduce taxes. This is done by exchanging investments that have declined in value for other investments with similar risk and return characteristics. This works especially well during market downturns, but can be done any time you have investments in a taxable portfolio that can be sold at a "loss."
The idea of selling low might sound like you're locking in a loss, but that's not the case if done right. Careful selection of which losses to harvest and what to buy as a replacement is imperative to avoid turning a tax loss into a permanent loss.
Left Coast Investment Strategies can help you determine if tax loss harvesting is right for you. We can help you pull off this counterintuitive move so you can defer capital gains, keep more of your proceeds, and avoid locking in a loss.
Know how much you need to save
Making payments toward a mortgage is like having a mandatory savings plan that diverts the principal part of your payment toward a long-term investment account in real estate. Selling real estate ends the savings plan and unlocks equity built up over time. Without having a defined savings plan in place, knowing how much is safe to spend and how much is necessary to save becomes critical to achieving long-term financial goals.
Figuring this out alone can be complicated and time-consuming. It requires taking an inventory of your assets, mapping out your net worth, defining your goals, accounting for streams of income and expenses, and projecting investment returns.
Left Coast Investment Strategies offers comprehensive financial planning services to help you figure out how much you need to save so can enjoy your lifestyle with confidence.
Know how to invest
Any amount not allocated toward taxes or spent immediately should be invested for the future.
Investment portfolios that are overly conservative can lose purchasing power to inflation. Portfolios that are overly risky can result in significant losses that wipe away years of hard work. Either error can result in not having enough capital when you need it.
It takes much research and work to come up with the right investment strategies, use those strategies to create a portfolio, then trade and maintain it over the years.
Some people turn to meme stocks and internet forums for investment ideas. Like fad diets, they rarely work. Others turn to rules of thumb, hopefully based on reliably researched evidence. However, rules of thumb that are right in aggregate are often wrong for individuals (unless you are truly the average investor).
Left Coast is here to help you put together and manage a sensible investment portfolio. This portfolio is designed to take the right risks, so you can grow and protect your savings over any timeline, long or short.
Marius is an investment adviser representative with Left Coast Investment Strategies and a licensed real estate broker with Columbia Partners Real Estate. Tax rules are subject to change. Please read the latest IRS publications for full details on the tax code and consult with a tax advisor for individualized tax advice.
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