Posted by Ronald * Starr on October 19, 2001 at 16:16:50:
Anna---------------
You are right. “When it seems too good to be true, it probably isn’t.” Think “IRS.” What comes to mind? IRS: “Let’s let real estate investors not pay any taxes on the gain of the sale of their property if they just do some refinancing.” or IRS: “Let’s get the taxes on the gain on the sale of their property, even if they don’t have any cash coming out of the sale because they financed it all out already.”
I vote for the later. So does the IRS.
I can not figure out what that person was thinking who told you that the loan amount reduces your taxible gain. I don’t know of anything that could cause somebody to think that. Maybe wishful thinking.
The capital gains tax is simple: tax on the capital gain which is the net sales price less basis. The net sales price is the gross sales price less expenses of sale, including recent fixup done to make the property more saleable–in the last 90 days before the sale, if I recall correctly. The basis is the purchase price less depreciation “taken or could have been taken” – means if you could have taken depreciation and did not, tough, IRS will still reduce the basis by the amount you could have taken–plus cost of capital improvements to the property.
That’s it. Simple. Oh, did you notice anything at all about borrowing money there? Loans? Mortgages? No. The IRS doesn’t care about the loans. And they don’t care how much cash you actually got out of the sale. If you did 100% finance last year and sell this year, you might have zero cash out of the deal now, right? Ok, fine, but you still have to pay taxes on the gain on the sale of the property. Where is the money to come from? The IRS doesn’t care. That is your problem.
I had a great time last week! Great workshop, Ed!!!
Someone in the workshop mentioned that if one refinances then the capital gain at selling time is only the selling price minus the refinance amount (vs purchase price). Is this true? It seems way too good to be true! If it’s true then can we still deduct improvement and other costs if the refinance is for less than 100% LTV? Or only such costs incurred after the refinance?
It was also mentioned that one can setup a corporation that “lends” the remainder of the money so that effectively the total refinance is for 100% LTV and one needs to pay no tax at all! Is it easy to set up such a corporation?
If the above is true then the value of 100% LTV refinancing is enormous! Are there short term loans out there (even if expensive) that can provide 100% LTV? What is the minimum seasoning that they require? Does the seasoning require holding the property for the specified amount of time or can we get away with just prepaying the mortgage for the required number of months?
Finally, if we have a WLOC, then can we legally “refinance” by somehow reusing the WLOC?
Sorry for having so many questions! It’s that I’m highly intrigued by this concept.
Re: Tax Implications of Refinancing - Posted by Sally (WA)
Posted by Sally (WA) on October 19, 2001 at 18:25:00:
Anna, perhaps it wasn’t the same conversation you are referring to, but I heard people discussing that when you purchase a property below FMV (e.g. 60% FMV) and you refinance at let’s say 90% LTV. Then the ‘borrowed’ spread is effectivly tax free. However, when it comes to selling that property, the tax man cometh, unless you do a 1031.