Previously: Part IV: I Become a Landlord
Part V: Sold! and the taxman cometh.
One of the few good things to come from all this was the bond and friendship we owners developed.
My pal, whose name I have somehow shamefully managed to forget, was now the Condo Association president and he kept an eye on my place for me as it sat empty. He knew I was desperately interested in selling. One happy day a woman approached him to ask if he knew of any units available for sale in the building.
“Well,” he said “this is a very desirable building and units rarely come on the market. But, as luck would have it, I do know one owner who might be persuaded to part with his.” And he gave her my number. Bless you and your subtlety, my friend. I should have remembered your name.
When she called my heart soared with the eagles. I wasted no time in arranging a business trip to Chicago.
We met. I showed her the apartment. She loved it. (It was, despite the bitter tale surrounding it, quite a nice place.) Turns out her boyfriend lived in the building and they wanted to be closer together. Guess what? His unit and mine shared an adjoining wall. They could, if they so choose, break this wall and create a single grand space.
Not only was this the building she wanted, my apartment was for her the most perfect one. If only she’d been stupid my stars would have been fully aligned. She was not. She was, curse it all, a lawyer.
“How much do you,” she said cooly, “want for the place?”
“Well,” I said as nonchalantly as I could manage, “I hear condo prices have been flat these past few years. I paid $45k for it back in ’79. I could let it go for that.” And then celebrate uncontrollably till my eyes fell out.
“I’ll give you $35k,” she said, not blinking. This is a beautiful moment; when in the course of negotiations you get to a price that works for you and the rest is just how much icing will be on this cake. The weight of years was finally lifting.
A bit of back and forth and we settled on $40k, not coincidentally what I owed the bank.
The deal went through without a hitch. It was the middle of 1985. After six long years I was free and it only cost me $26,960. $5,000 loss on the sale and the $21,960 total of the monthly losses.
Of course, I’d had some tax breaks along the way that softened this a bit, but who’s counting?
The IRS, as it turns out, was counting.
According to them, I had a $15,000 profit and I now owed a $3,000 (20% at the time) capital gains tax on it. Surprised? Well maybe not if you’re one of the real estate pros who read this blog, but I was stunned.
For the rest of us, here’s how.
As I mentioned, with all that cash bleeding away each month, I was desperate for some relief. Turns out when you own investment real estate the acceptable business model allows you to assume the building will wear out over time. This is called “depreciation” and it is considered an operating expense. As such, it is deductible in the eyes of the IRS. Further, back when I was doing this there was an option called “accelerated depreciation” and this is exactly what it sounds like. You can choose to state that your building is wearing out at a faster rate and thereby take a larger deduction. Of course, I grabbed this with both hands like the drowning man I was.
Now here’s the thing. The IRS is nobody’s fool. When you sell they are going to want their cut on your capital gain. Your capital gain (or loss) is not the difference between what you paid and what you sell it for. It is the difference between your “cost basis” and what you sell it for.
“But wait,” I hear you say, “you sold at a loss, JL. You sold for $40k and you paid $45k. There is no gain to tax.” You are half right. There is no gain, but there is a $15k “profit” to tax. “Cost basis,” you see, is an entirely different thing that what you paid for the place.
The problem is the depreciation I’d been taking must now be accounted for. It amounted to $20k over the years. This $20k reduced my cost basis from the $45k purchase price to an adjusted cost basis of $25k. Since I sold for $40k, voila! A $15k taxable gain.
Here, finally, my sad tale ends. This is the final tally:
- $21,960 in operating losses
- $5,000 capital loss on the sale
- $3000 capital gains tax
- $29,960 down the tubes
That, my friends, in the early 1980s was serious cash. When I really want to depress myself I calculate that invested in a fund like VTSAX it would be worth around a quarter million dollars by now.
I shoulda bought a Porsche.
