Q: Mr. Frost: My husband and I are selling a 4-family apartment building in St. LouisCity(an area that is, unfortunately, going downhill fast). Would it be best to pay off debt with the proceeds? (house mortgage/one car payment/very little credit card debt.) Or, would it be better to reinvest in rental property in a different area of St. Louis? We are not expecting a windfall, probably about $68,000.00 in our pocket when all is said and done. However, we understand the capital gain s tax would take a significant percentage if we do not reinvest in real estate. Is it better to lower debt? or...put the $$ toward rental property in another area and make payments with the rental income? Any thoughts you might share would be appreciated.
D. AuBuchon
A: Dear D. AuBuchon:
You may want to reconsider rolling your profit into another rental property verses paying off debts. If you don’t purchase another property you may take a tax hit from a number of different angles. First, you will have to pay capital gains tax of 20% if you have owned the property more than a year. With your gain of $68,000, that will cost you $13,600 in federal tax right off the top. If you pay off mortgage debt with your proceeds you will lose a significant tax deduction on the interest that you pay on your home mortgage. If you are in the 27% tax bracket, paying down your mortgage will cost you $27 dollars in tax for every $100 you would have paid in interest. If you purchase another investment property you can defer your capital gains by taking advantage of an IRS 1031 exchange. To take advantage of this rule you will have to instruct the title company to take the proceeds of the sale and put the money in an escrow account. Taking the cash will taint the transaction in the eyes of the IRS and they may disallow the exchange. You have up to 180 days to close on another investment property. However, you must identify a new property within 45 days of the sale of your existing property. For more information please consult your tax advisor. Good Luck.
Jerry Frost
