Q: My husband and I own two investment properties. We’re thinking of selling them in the near future.

Is it a good idea to do a cash-out refinance and get all the equity out of homes? We would then sell the properties to avoid taxes on the sale.

A: I think you’re a bit confused on how capital gains are taxed on investment property profits.

You cannot avoid paying taxes on your profits, unless you are using a 1031 tax free exchange. A tax-free exchange would allow you to swap these two investment properties for another (or several others) that costs at least as much as the sales price of the two together.

In other words, if you’re selling your two investment properties for $500,000, you’d have to buy a replacement property, or several properties, that cost at least $500,000 in order to make the swap and defer all capital gains taxes.

Whether you have a mortgage on the properties or not may be immaterial when it comes time to count your profits. Your profit is the difference between the cost of purchase plus the cost of any improvements made to the property plus the cost of selling the property (i.e. broker’s commission, transaction costs) subtracted from the sales price.

On top of profit, you’ll have to pay the 25 percent recapture of any deductions or depreciation you took on the property over the years.

Please talk to your accountant or tax preparer or real estate attorney for more details.

Published: Nov 14, 2006