Friday Rant - Debt does not Equal Tax Loss

OK, here's my free bit of tax assvice, of special relevance in a falling real estate market. If you are selling a piece of investment property (such as a house you built as an investment), keep in mind that the fact that you will owe all of the proceeds and then some to the bank is not in and of itself proof positive that there will be no taxable gain on the sale. It is easy to get misled on this, because if my conversations over the past week are any indication, anyone and everyone who wants the sale to go through will try to convince you otherwise. The real estate agent will tell you you can't possibly have any gain because the bank is getting all the proceeds. The builder will tell you the same thing. The lender (the one who is getting all the proceeds and then some) may well tell you this. The escrow company may not tell you this because they are smart enough not to to commit to anything, but they will try very very hard to get your accountant to tell you this because they want the escrow to close no matter what. Your dog, if he or she wants the property to sell bad enough, will tell you this.

The truth: It doesn't matter how much money you took out and how much you are currently in hock for. What matters is whether the proceeds from the loan were used to pay for costs to the property that is currently for sale. The same individual who tells me a certain property could not possibly sell for a gain because the entire proceeds are going to bank, goes on in the next breath to tell me in loving detail about the $70,000 free standing rec room, built with loan proceeds, which was subsequently torn out when the owner decided to build an investment property. There's $70,000 in loan repayments right there that has nothing to do with the cost of the property currently being sold. (Although the costs of tearing out the rec room to build the new house would qualify.)

Why would this hold up the sale? Well certain states demand a hunk of tax money up front if there is going to be a gain on the sale. Some particularly budget-strapped states want a certain flat percentage if there is going to be any gain on the sale at all, even if the gain is miniscule or if the taxpayer's other income is so low that the gain will not result in any tax. If the bank wants all of the proceeds and the state wants some of the same proceeds, cash flow is going to be a problem. (Going into the investment business at all if you don't have enough of a cash cushion to cover situations like this is the subject of another rant.)

Of course the above is completely hypothetical and none of the comments above should be interpreted as actual tax advice. (Assvice is one thing; advice is another. Consult your tax professional. But not your real estate broker, lender, builder, or even your dog, on this one.)