We’re glad that you plan to use a real estate lawyer to help you in this process. You didn’t say how much money you put into the upgrades to the home, but the amount could be relevant.
If you put in about $50,000 in improvements, for example, you won’t have much in terms of a profit on the sale of the home. You may actually have a loss. Given the costs you might have incurred in buying the home and costs you incurred in then selling the home, the sale of the home might have very little impact on your federal income taxes.
Usually, there are two issues when you sell an investment property after you have held onto it for several years. One of those issues is the amount you’ll pay in capital gains taxes. Since you’ve owned the property for more than one year, your profits on the sale of the property should be taxed at capital gains rates at a maximum rate of about 20 percent plus the additional 3.8 percent tax.
In your case, you probably won’t have much in capital gains so you probably have little or no taxes to pay there. On the other hand, you probably had tenants in the rental property and you depreciated the property during the last three or so years. If we take your purchase price of $225,000 and divide that by 27.5 years — the number usually used to amortize real estate — you probably took about $8,200 in depreciation each year. But if you are not in the business of real estate (as a full-time real estate professional of some sort), you might have been limited in the amount of losses you could take on the investment property each year.
If you didn’t get any tax benefits from the investment property for the past several tax years, the sale to your kids will have little impact on your taxes. Furthermore, if you sell them the property on an installment basis, you can spread out the payments over the years of the sale and continue to minimize any tax consequences to you.
We’d really like you to talk to an accountant and have him or her walk through your options here. If you used an accountant to prepare your taxes the last several years, you’ll need to understand how they treated the investment taxes on your tax return to understand how the sale may impact you going forward. It may be that your kids could simply buy the property from you, get a mortgage, give you the money and they would end up as the owners and you as the former owners with cash in hand from the sale.
Ilyce Glink is the creator of an 18-part webinar+ebook series called “The Intentional Investor: How to Be Wildly Successful in Real Estate” as well as the author of many books on real estate. She also hosts the “Real Estate Minute” on her YouTube channel. Samuel J. Tamkin is a Chicago-based real estate attorney. Contact them at ThinkGlink.com.