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Have you considered using a 1031 exchange to exchange your current rental property for something closer to where you'd relocate to? That would defer the taxes related to the property sale but not eliminate them.

Another option might be to sell the property and provide seller financing to the buyer which I believe would spread out the tax payments over a longer time frame.

Or you could hire a local property manager to provide property management services on the existing property if you move too far away to be the property manager.
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I guess other than taking any losses, you just have to pay the LT gain taxes on it and be happy you have gains rather than losses?

Generally, true!

You bring up a question I've had, but hadn't really investigated much except to look at the IRS site and try to figure out the word salad there: when you have a significant cap gain, are you filing a 1040-ES immediately? That form is structured as if you know exactly what amounts you have with quarterly payment coupons attached. If you only have a large gain in May, for example, the April coupon is irrelevant. I'm assuming you simply use the coupon that applies to the quarter in which you had a gain. Anything I'm missing here?

Basically, how are you paying the IRS its due without incurring its wrath (i.e. the dreaded penalty)?

Pete
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You don't have to make an estimated tax payment as soon as you have a large capital gain as long as you can meet one of the safe harbor provisions. The simplest one is to pay 100%/110% (based on your last year's AGI) of your last year's tax liability evenly though the year by withholdings and estimates. There are other safe harbors which may require smaller payments up front and a larger payment at the end, but the calculations are more complicated. Also withholdings are deemed to be paid evenly through the year even if back loaded at the end of the year.

Ira
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My other issue is that I may relocate and if I do, I will end up with some sizable taxes (recapturing depreciation, house significantly increased in value) on the house sale since it has largely been a rental for at least 50% of the 17 years I've owned it.

In different times (no virus, or if the house didn't seem to be at peak value) I might rent it out since it is almost paid off but so close to retirement, I'm not willing to take that risk. It (house value) represents a good 25-35% of my total net worth at today's value. And the only reason I rented it previously was due to the housing collapse in AZ (2008-2011) and my thought of retiring to it but that has changed.


Given everything going on in your situation, it might be worthwhile to visit a tax professional (probably after July 15). They may be able to provide you advice on how to minimize your liability on the sale. Depending on when you are relocating, if you could wait until January to close on the sale, you wouldn't have to pile the capital gains you've already realized on top of the ordinary income from the recaptured depreciation, plus your income from work. That may keep you from having to pay the 3.8% Medicare surtax on investment income, for instance.

AJ
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The simplest one is to pay 100%/110% (based on your last year's AGI) of your last year's tax liability evenly though the year by withholdings and estimates.

Thanks, Ira. Difficult to get that statement out of the IRS docs!

So if I'm reading your response correctly, if I'm already paying 100% + of 2019's AGI on my base income (job), but my total income increases by 50% from cap gains (of which I am not currently paying any taxes on), I do not need to pay these taxes until 2021 and without penalty?

Thanks

Pete
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If your 2019 AGI was under $150K ($75K if you file MFS), then your 2020 withholding must be more than 100% of your 2019 tax liability. If your AGI was over the limit, your 2020 withholding must be more than 110% of your 2019 tax liability. You can pay the balance of your 2020 tax by April 15, 2021 without penalty.

Again, there are other methods which may yield a smaller upfront payment, but you will need to do more work to calculate their requirements.

Ira
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My other issue is that I may relocate and if I do, I will end up with some sizable taxes (recapturing depreciation, house significantly increased in value) on the house sale since it has largely been a rental for at least 50% of the 17 years I've owned it.

If you are single, you will pay no capital gains tax on the first $250,000 you make when you sell your home, $500K for married couples. In order for the sale to be exempt, the home must be considered a primary residency based on Internal Revenue Service (IRS) rules for at least two of the last five years.

Can you live in the house two years prior to selling it? The last 17 years don't drive the exemption...just the last five. (There may be some other details to work out, like how to handle depreciation and expenses you may have deducted while it was a rental business.) It sure seems worthwhile to have a tax pro point you in the right direction if you can potentially make 10's or 100's of thousands of dollars tax free, and can live in that particular house for two years.
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I will end up with some sizable taxes (recapturing depreciation, house significantly increased in value) on the house sale since it has largely been a rental for at least 50% of the 17 years I've owned it.

If you are single, you will pay no capital gains tax on the first $250,000 you make when you sell your home, $500K for married couples. In order for the sale to be exempt, the home must be considered a primary residency based on Internal Revenue Service (IRS) rules for at least two of the last five years.

Can you live in the house two years prior to selling it? The last 17 years don't drive the exemption...just the last five. (There may be some other details to work out, like how to handle depreciation and expenses you may have deducted while it was a rental business.) It sure seems worthwhile to have a tax pro point you in the right direction if you can potentially make 10's or 100's of thousands of dollars tax free, and can live in that particular house for two years.


Sorry, even if the OP lives in the house for 2 out of the last 5 years (which I think he has), he's probably going to owe some ordinary income taxes, and may owe capital gains taxes, given the circumstances described. With the property being a rental for at least 8.5 years, there will be two things that impact the taxes on sale of the property:

1) The basis will be adjusted by the depreciation, making the basis lower, so there will be a higher capital gain. Given that the standard depreciation schedule is 27.5 years, and the home has been a rental for at least 8.5 years, that could be a pretty substantial downward adjustment - almost 1/3 of the original basis. Since, IIRC, the OP is single and the house has significantly appreciated in the last few years, and he has stated that the home's current value is a substantial portion of his net worth, it seems likely that the capital gains after adjusting the basis will exceed $250k. If that's the case, he will owe capital gains taxes on the gain over $250k. (Please note - even if he hasn't lived in the house for 2 out of the last 5 years, if he's moving more than 50 miles away for work, he may be eligible for a partial exemption based on the amount of time he's lived in the property during the last 5 years.)

2) Depreciation will be recaptured and taxes will be owed on that recapture. Depreciation recapture is calculated outside the capital gains exemption and is applicable to those who have rented their property out, and those who claimed the previously allowed home office deduction.

Please see IRS Pub 523 https://www.irs.gov/pub/irs-pdf/p523.pdf for confirmation of these 2 impacts:

If your space is considered as residence space at the time of the sale, then your former business usage DOESN’T affect your gain/loss calculations, unless you took or were allowed to take depreciation for use of your home for business or rental purposes. See Worksheet 2, line 5, below. where Worksheet 2 provides the details of how the basis will be lowered by the depreciation that was (or could have been) taken.

and Recapturing Depreciation

If you used all or part of your home for business or rental after May 6, 1997, you may need to pay back (“recapture”) some or all of the depreciation you were entitled to take on your property. “Recapturing” depreciation means you must include it as ordinary income on your tax return.


AJ
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Can you live in the house two years prior to selling it?


Could I? Yes. Is it likely? No. The prime reasons for moving is to be closer to my father as he gets older and to get a job back east and my clearance (security) expires in 2 years from when I last left so that doesn't really leave me a good window.



Thanks.
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AJ,

Thanks for confirming most of my suspicions based on past research here and elsewhere.

I could always roll the dice and if I move, simply keep the house and rent it out and delay the tax situation since the house is virtually paid off and is in a desirable area. I'm unlikely to do that due to the risks of getting a terrible tenant/damage to the house, I'd like to use the proceeds to either pay cash on the next house (or keep it conservatively invested while have a mortgage in retirement).

An easier question, the cap gains would be 15% (except for higher incomes)?
If the gain (made up number) was $300K then the taxes would be $45K? Obviously you can adjust the basis for improvements, etc.
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An easier question, the cap gains would be 15% (except for higher incomes)?

Well, depends on how much 'higher' you consider 'higher' income to be. For singles, the cap gains brackets for 2020 are:
0% up to $40,000;
15% for $40,001 up to $441,450;
20% for $441,451 and up

But wait, there's more! There is also a net investment tax surcharge of 3.8% that kicks in on all investment income (gains, dividends and interest) that starts at $200,000 for single filers.

Here's an article that has details, and shows the brackets for other filing statuses https://www.forbes.com/advisor/investing/capital-gains-tax/

If the gain (made up number) was $300K then the taxes would be $45K? Obviously you can adjust the basis for improvements, etc.

$300k in capital gains alone for a single filer would trigger the 3.8% surcharge on part of the capital gain. How much of the gain will be subject to the surcharge will depend on how much other income you have. (And keep in mind, your realized gains from your taxable stock accounts are counted as part of those calculations.) Plus, with $300k in gains, if you have over $141,450 in taxable ordinary income, you would be pushed into the 20% rate for some of the gains. And the depreciation recapture will be counted as ordinary income.

And all of that is why you should consult with a tax professional in your situation. As I suggested previously, if you could delay the closing until January, that would allow you to not stack the gains from the sale of the house on top of the already realized gains from your taxable account. And if you, for instance, were to seller-finance the property (maybe with a balloon payment in 2024 or 2025 - before the rates revert), you could recognize a small part of the gain each year until the balloon payment was made. Or you may be able to do a 1035 exchange. But all of that advice would require a lot more information than you probably want to post on a public message board.

AJ
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There's one more complication.

Because the house was used as a rental before it's use as a principal residence, it's quite possible that not all of the gain can be excluded as a principal residence. The term of art is "non-qualified use".

This was a law change effective 1/1/2009. You look at the period of rental use after the law went into effect and divide that by the total ownership period. That portion of the gain on sale is not excludable under IRC 121 (that's the $250k or $500k exclusion that many people are familiar with).

--Peter
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Have you considered using a 1031 exchange to exchange your current rental property for something closer to where you'd relocate to? That would defer the taxes related to the property sale but not eliminate them.

Another option might be to sell the property and provide seller financing to the buyer which I believe would spread out the tax payments over a longer time frame.

Or you could hire a local property manager to provide property management services on the existing property if you move too far away to be the property manager.
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AJ,

I sent an email to a CPA that I've worked with in the past and did get a rough estimate of the potential taxes involved. I'd not going to go into details here but it does approach 6 figures. It would drop a little if I got married or met the 2 of 5 years to reduce a bit of the taxes but obviously a painful amount.

Thanks for all of your help on this board to me and others.

Rich
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I sent an email to a CPA that I've worked with in the past and did get a rough estimate of the potential taxes involved. I'd not going to go into details here but it does approach 6 figures. It would drop a little if I got married or met the 2 of 5 years to reduce a bit of the taxes but obviously a painful amount.

Ugh, takes a bit out of what you thought you would net, doesn't it? Glad you did check with the CPA. Not a good message to hear, but it's better to know going into the process than to find out when you are doing your taxes for the year you sold. Now you can do some planning in order to minimize the liability.

Thanks for all of your help on this board to me and others.

You're welcome. Glad I could help.

AJ
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Hi,

I am looking for the tax rule for estimating penalty if I did not pay estimated tax at all but paid the tax due with the tax return. My AGI for 2019 was quite high but because of various deductions etc the taxable income and the tax I paid were low. This will not be the case for 2020 tax year.

Please help.

Thanks.
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Sorry, I forgot to mention that most of my income is from capital gains, mainly long term. This was the case in 2019 and also will be in 2020. I would not know the actual gain until the end of the year.

Cheers.
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I was looking for an answer from Google. I found from TurboTax
https://tinyurl.com/y9qzmmfw

" If your prior year Adjusted Gross Income was $150,000 or less, then you can avoid a penalty if you pay either 90 percent of this year's income tax liability or 100 percent of your income tax liability from last year (dividing what you paid last year into four quarterly payments). This rule helps if you have a big spike in income one year, say, because you sell an investment for a huge gain or win the lottery. If wage withholding for the year equals the amount of tax you owed in the previous year, then you wouldn't need to pay estimated taxes, no matter how much extra tax you owe on your windfall."

My 2019 AGI was less than $150K. So can I send IRS 100% of my 2019 tax in one installment right now to escape any penalty?

Thanks.
alpha
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My 2019 AGI was less than $150K. So can I send IRS 100% of my 2019 tax in one installment right now to escape any penalty?

Not unless the payment is from withholding. If you are making estimated tax payments, that still needs to be on a quarterly basis, as stated in what you quoted: (dividing what you paid last year into four quarterly payments) and your first two quarterly payments were due yesterday, 7/15/20. Because of that, you may still end up with a penalty by making a payment today.

If you have an IRA that you can pull money from without incurring a penalty, then you can have 99% or 100% of a distribution from that IRA withheld to qualify as withholding to avoid a penalty.

AJ
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If you have an IRA that you can pull money from without incurring a penalty, then you can have 99% or 100% of a distribution from that IRA withheld to qualify as withholding to avoid a penalty.


As AJ said, the payment has to be from withholding. A lot of retirees don't have anything withheld from pensions, SS, etc, and just do one large IRA withdrawal with 100% withheld late in December. Large enough to satisfy the Safe Harbor to avoid the penalty.

Until I discovered this trick a few years ago, I was always trying to get my pension withholding right. And was never able to. I cycled back and forth between way too much and way too little.
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Thanks for the clarification.

I found out my tax obligations for 2019 only a few weeks ago when I completed my tax return using turbotax. If I remember correctly, in earlier years TT used to generate 1040-ES forms, but did not do so this time.

Anyway, I will make the payment as planned using the form for the 3rd payment (due Sept 15) and pay the (small) penalty next April.
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