If I sell investment property for less than the adjusted basis, do I owe capital gains?

August 12, 2011

From:  John
Date:  14 Oct 2008

I purchased property in 2005 for $1,100,000 using about $450,000 from proceeds in a 1031 exchange as a down payment. My adjusted basis was about $650,000. The original mortgage for the property was about $500,000. After one year I refinanced for $797,000 and took $297,000 in cash. Now the fair market value of the property is about $600,000.

If I short sale or walk away, am I still responsible for the full capital gain tax? If I sell for less than the adjusted basis, am I still responsible for capital gains taxes?

Thank you

John

Answer

Date:  5 Nov 2008

Hello John,

If the sale price of the property is the fair market value, which you estimated was $600,000, and given your tax basis of the property was $650,000, you will probably have a loss relating to the sale. If this was a rental property, the loss could be an ordinary Section 1231 loss.

You will have ordinary cancellation of debt income of about $797,000 - $600,000 = $197,000.

To really see how your situation will settle out, you need to consult with a tax advisor. That’s our business!

Good luck!
Mike Gray

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