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I'm selling an investment property. It is not eligible for a primary residence exemption. I am not interested in purchasing another investment property (i.e. doing a 1031 exchange). So I will pay taxes on the profits of this sale.

Are there ways that I can reduce this tax? I've considered deferring salary at my job. This could save me about 3% (the difference between 25% and 28% tax brackets). I doubt this is worth the hassle, though. And I'm sure there are risks that I'm not thinking of.

Any other options? Is there a low-risk investment property financial instrument that I could do a 1031 exchange with? I don't need this money any time soon. I'd be fine to lock it up for up to three years.

  • Do you have to sell the property? Why are you selling? – mbhunter Jun 11 '13 at 6:37
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    I don't have to. The main reason I'm selling is cashflow. The "investment" is costing me money each month. This is mostly because I chose to do a 15yr mortgage. But it's a condo, so I'm also paying HOA each month. – three-cups Jun 11 '13 at 14:55
  • Raising the rent won't work? – littleadv Jun 11 '13 at 17:25
  • It would work, but I'm not sure how much more I can raise it. I've run several scenarios in a spreadsheet looking at cash flow and equity positions. This option seemed like the best. But I'm no expert. – three-cups Jun 11 '13 at 23:44
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Property sold at profit is taxed at capital gains rate (if you held it for more than a year, which you have based on your previous question). Thus deferring salary won't change the taxable amount or the tax rate on the property. It may save you the 3% difference on the salary, but I don't know how significant can that be.

The 25% depreciation recapture rate (or whatever the current percentage is) is preset by your depreciation and cannot be changed, so you'll have to pay that first. Whatever is left above it is capital gains and will be taxed at discounted rates (20% IIRC).

You need to make sure that you deduct everything, and capitalize everything else (all the non-deductible expenses and losses with regards to the property). For example, if you remodeled - its added to your basis (reduces the gains). If you did significant improvements and changes - the same. If you installed new appliances and carpets - they're depreciated faster (you can appropriate part of the sale proceeds to these and thus reduce the actual property related gain). Also, you need to see what gain you have on the land - the land cannot be depreciated, so all the gain on it is capital gain.

Your CPA will help you investigating these, and maybe other ways to reduce your tax bill. Do make sure to have proper documentation and proofs for all your claims, don't make things up and don't allow your CPA "cut corners". It may cost you dearly on audit.

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