The Depreciation Factor When Selling Your OBX Beach Home

In the height of the real estate boom from 2002 to 2006, doing a 1031 Tax Deferred Exchange
was such a common occurrence. We think about it a lot more in a rising market. However,
even though the Outer Banks market is still in recovery mode, a 1031 exchange may still be a
very necessary process, even without massive profits from actual sales price. All due to one
word…depreciation.

Specifically the way it works is the gain, not the profit or equity, from the sale of your
investment/beach/second home could be subject to Federal and State taxes. Also subject to
federal taxes at the time of sale is the depreciation taken over several years on the property.
That amount is taxed at a whopping 25%!!! This could really sneak up on you!

Below is an example of how to determine a potential capital gain when selling without an
exchange.

Step 1: Calculate the Basis
$300,000 Original Purchase Price
+ $ 50,000 Improvements that haven’t been expensed in a previous tax year
– $ 60,000 Depreciation taken
$290,000 Net Adjusted Basis

Step 2: Calculate Capital Gain
$475,000 Sales Price today
– $290,000 Net Adjusted Basis
– $ 25,000 Cost of Sale (commissions, transfer tax, fees, etc)
$160,000 Realized Capital Gain

Step 3: Calculate Capital Gain Tax Due
$15,000 Recaptured Depreciation = 25% x Depreciation taken
$24,000 Federal Capital Gain Tax at 15% x Realized Capital Gain
$32,000 Federal Capital Gain Tax at 20% x Realized Capital Gain

Please Note:
* Income less than $39,375, the long term capital gains tax rate is zero
* 15% if income is less than $434,550 20% if income is more than $434,550
* This does not include any potential state capital gain taxes

What can you do if you want to sell and avoid paying Federal Capital Gains Tax?
– You can defer the federal tax by performing a 1031 exchange for a property of equal or
more value than the property you are exchanging, and acquiring the same.
debt/mortgage equal to or exceeding the debt on the relinquished property.
– You can move into the home and make it a primary residence for 2 of the last 5 years
and rollover up to $250,000 if single and $500,000 if married.
– You can reduce tax liability by doing some major improvements that are not expensed in
any previous tax year.

This is an overview of the process. For more detailed information on your specific tax
implications contact a tax professional. To find out more about doing a 1031 Tax Deferred
Exchange we recommend Realty Exchange Corporation at www.1031.us.

Although it sounds reasonable to think with all the guests coming, it would be better to just sell the home in the fall or spring, take a look at these six (6) reasons you could be missing out by waiting. Contact me today if you want more information!

1. Outer Banks Inventory

Inventory has been our biggest challenge in terms of pricing.  June, July, and August are historically the time of year when our inventory is the lowest.  Why not take advantage of that incredible opportunity? Lower inventory could mean higher prices.

2. High Volume of Visitors

The Outer Banks will have over 3 million visitors each year.  Obviously, the majority of those folks visit during the summer months.  We cannot get that kind of exposure any other time of year!

3. Perfect Time of the Season

The home is fully open and operational.  Buyers will have inspections done before closing.  When the house is winterized during the fall/winter there are extra costs to open the house back up for those inspections.  Right now, everything is up and running and easy to inspect and ensure to the buyer the home is in good condition.

4. Sweet Outer Banks Summertime

It’s a beach house!  When does the beach look the best?  Summertime of course. Your beach house will show the best with the sun shining, deck chairs out, pool open, hot tub running!  Buyers get excited about these things and it helps to sell your home.

5. Serious Inquiries

Buyers this time of year are serious about buying!  If a potential buyer is going to take time out of their much-anticipated vacation to look at your home, it means they are serious about buying.  They’re here with all decision makers too.

6. Outer Banks Rental Income & Fees

With the average transaction taking 45 to 60 days to close, sellers can collect most or even all of the rental income.  A late summer or early fall closing also means sellers don’t have to worry about fall maintenance and carrying the home through the winter months.

So, what does all of this mean? Most property owners we speak to all say the same thing. “We
don’t HAVE to sell.” Which is very true, especially when a seller is not physically moving from
the home. The main reason they say that is because the pricing strategy presented in
alignment with the current market statistics is typically lower than they had hoped for.

It’s no secret, the Northern Outer Banks market is still in the midst of recovery, now with a
rising inventory. We’ve tracked these cycles for many decades and the results are always the
same. It’s a 20 year cycle. If the major down happened in 2009, we are merely half way
through before the next possible boom, based on recorded history.

Now, if you find yourself in the very common situation of having a home here on the OBX that
you aren’t using as much anymore, don’t like the current market price, and feel like you don’t
have to sell it, here’s what you need to know.

What exactly are my options if I don’t have to sell?

1. 1. Recognize the big picture. Just because you don’t HAVE to sell, does not automatically
   mean that keeping the home is the best financial decision. Talk to your financial planner
   and tax advisor and get their opinion of the big picture financially.
2. Consider the amount you personally use the home. If you’ve gotten to the point of
   only visiting the home once a year, it could actually end up costing you more in the long
   run to keep it. We have very extreme weather on the Outer Banks. Homes left alone
   with deferred maintenance can often times develop big ticket repair items the longer
   they sit.
3. Place the home in a trust. If you have children who are available and willing to step in
   and take over the management of the home, there could be some tax advantages in
   your estate by leaving the home to them in a trust. Check with a tax advisor for more
   detailed information. I found this article helpful as a starter.
4. Consider making improvements. Outside of the economic market conditions of supply
   and demand, one of the other reasons some homes are experiencing a challenge on
   pricing is due to being in the original state. Buyers today have very different
   expectations of homes than they did when I started in 1997. If you are planning to keep
   the home for a few more years, do the improvements, enjoy them, then sell when you
   are ready. One word of caution, consult a real estate professional first so they can help
   you maximize where to spend your money so it makes the most impact to a future
   buyer.
5. Place the home as a year round rental. Yes, that means less income overall. It also
   means less expense. Tenants in a year round situation generally pay their own utilities,
   do the cleaning, change the filters and more. There is a huge shortage of affordable
   year round rental homes in the area. This is also something you can manage yourself,
   with very little time and energy. Hire a maintenance guy to check on the place and
   handle the minor issues that come up. If you’re already not using the house, why not
   have just one family enjoying it year round.
6. Consider short term retirement in the home. So many buyers I’ve worked with over
   the years actually bought the home for future retirement. It’s unclear why more don’t
   actually do it. However, if you decided to just retire here for 5 years, enjoy the beach,
   do some improvements, the home could have a much different value then.
7. Take a closer look at what the home is costing each year to own. This is probably the
   best advice I can give. More often than not, the amount needed to price strategically
   compared to the amount it will cost to own the home for another 3 to 5 years is usually the same. I know it can be challenging to drop that price another $25,000 in order to
   sell, but what will it cost you to own it annually for the next 5 years? That’s not
   including any major deferred maintenance that will come up along the way.

The truth is, timing is everything. If you’re ready to sell, take a serious look at these options
and decide the best course of action. First of all answer the most important question I
presented in the beginning….

Just because I don’t HAVE to sell, does that mean keeping this home is in my best financial
interests?

When you commit to looking at the big picture, as well as all other possible options and
calculate the best move for your situation. If you need help discussing these or any other
strategy, please feel free to reach out!