Chandler Properties Blog

A couple of years ago, I saw a billboard w/ Donald Trump promoting the Learning Annex in Atlanta, Georgia.  This was during the height of the Apprentice and I thought it would be a good way to see Donald Trump and Robert Kiyosaki in person. 

For those of you that aren’t familiar with The Learning Annex, it is a well organized program that includes many of the top “self help” gurus.  They promote everything from real estate investing to “How to be a Better Person” seminars.  The programs are high energy level and push strongly toward selling products.  The prices for the products generally range from $500 to $5,000.

After my dad and I purchased our tickets separately for about $150 a piece, we were each sent a package with a couple extra tickets enclosed.  I thought this was a little unusual since they had just charged us $300 for two tickets, that they would accidentally enclose an extra $600 of tickets.  What was really a coincidence was that my dad got extra tickets when his package arrived the next day.  A day or two later we each got a pre-recorded phone call from the Learning Annex saying they had accidentally included the tickets, but since it was an honest mistake we could go ahead and bring a couple friends for free.  (This is when I started to get a feeling this wasn’t going to a learning seminar, but a “hold onto your wallet” marketing free for all.) 

Anyway, dad and I still wanted to see Trump so we started looking through the itinerary to determine what time on the weekend he would be speaking.  We live two hours from Atlanta and were going to drive down that day and see him speak and not go to both days of the seminar.  My dad called the Learning Annex to get the time and day of his speech.  This is when the “Bologna” got real good.  They informed us due to security reasons, they could not disclose when the main speakers would be speaking over the weekend.  Not even, which day. WTF!  These guys have some serious brass to use that line. Can you imagine if you bought tickets to Game 7 of the World Series and they would only narrow down the time of the game to a 48 hour time period in the fall.  As a consolation, there will be plenty of minor league games playing that weekend for you to watch while you are waiting.  People would storm the Major League baseball office in protest.

My opinion as to why they did this was to make people show up and sit through all the extra high pressure sales gurus.  I would guess the Learning Annex gets some sort of commission off sales and they knew no one would want to listen a “no name” sale his product. 

After this incident, we decided this was probably not a learning event, but a marketing event and therefore did not go the actual event.  I am interested if anyone has been to these events and had a similar experience.  If you have a similar story, feel free to post a comment.

Overview
This article is Part II on calculating taxes on rental properties.  Part I covered taxable income from ongoing operations.  This article will cover calculating gains/losses when a rental property is sold.

Depreciation Recapture vs. Capital Gains
When a property investor sales a rental property, the gain/loss is calculated by subtracting its adjusted basis from the sales price.  The adjusted basis in  the property is calculated by starting with the original purchase price, subtracting annual depreciation deductions, and adding back capital improvements.  This total taxable gain has to be broken into two tranches to determine the taxes owed on the gains.  Generally speaking, the gains from sale of property are treated as capital gains and taxed at 15%.  However, the taxable gains related to the previous years’ depreciation are taxed at 25%.  This piece is known as depreciation recapture.

Let’s examine how this works with a simple calculation.  Joe Landlord purchases a property for $200,000.  In year 6 he adds a new roof for $13,027.  At the end of year 6, he sells the property for $300,000.  

Question:  What is the tax liability on this sale?

Example:

                            Depreciation        Increase        Adjusted
                             Deduction            in Basis          Basis  

Original Cost                                                        $200,000

Year 1                    $6,970                None           $193,030

Year 2                    $7,272                None           $185,758

Year 3                    $7,272                None           $178,486

Year 4                    $7,272                None           $171,214

Year 5                    $7,272                None           $163,942

Year 6                    $6,969                $13,027       $170,000
                            $43,027

Sales Price                                            $300,000

Adjusted Basis                                      $170,000

Total Gain (Sales Price - Adj Basis)      $130,000

  Gain Due to Depreciation                     ($43,027) x 25% = $10,757

  Remaining Capital Gain                        $86,973   x 15% = $13,046    

    Total Tax                                                                           $23,803

Results Summary
As we can see from the above example, the previous $43,027 of depreciation deductions Joe took must now be recaptured at sale date at 25% instead of the 15% capital gains rate.  The remaining capital gains of $86,973 (Total Gain - Depreciation Recapture) is taxed at 15%.  To answer our above question, Joe has a $23,803 taxable gain from the sale of his rental property.

This is not bad for two reasons. 1.) We have been able to defer paying taxes for several years by taking depreciation deductions.  2.) Most rental property owners fall into a 25% or higher tax bracket and therefore not being taxed at a rate higher than they would have been originally.

I hope this article presents a clear example of how the IRS Depreciation Recapture rules effect gains on sale of rental property.  If you have any questions or comments, feel free to post them below.