What Actually Comes Out of a $5 Million Sale

Jean-Baptiste Colbert was Louis XIV's finance minister, and he described his craft plainly. The art of taxation, he said, consists in so plucking the goose as to obtain the largest quantity of feathers with the least possible amount of hissing.

I have thought about that line for most of forty years. What strikes me is not the cynicism. It is the accuracy. Most sellers I meet have no idea how many feathers are coming out, and by the time they find out, the hissing does no good at all.

So let us do the arithmetic together. No strategy, no product, no recommendation. Just the numbers that a conventional sale produces.

The facts.

An investor sells a commercial building for $5,000,000. He bought it years ago for $2,000,000. He has taken $900,000 of depreciation over the hold. Selling costs, including commission, run $300,000.

That gives us an amount realized of $4,700,000 and an adjusted basis of $1,100,000. Total gain: $3,600,000.

What comes out.

The gain does not get taxed once. It gets taxed in pieces, at different rates, by different authorities, all on the same day.

1. Unrecaptured Section 1250 gain. The $900,000 of depreciation he claimed comes back at a maximum federal rate of 25 percent. That is $225,000.
2. Long-term capital gain. The remaining $2,700,000 is taxed at 20 percent at this income level. That is $540,000.
3. Net investment income tax. An additional 3.8 percent applies to the full $3,600,000 under Section 1411. That is $136,800.
4. State income tax. At a blended 9.3 percent, that is $334,800. A different state produces a different answer, and a handful of states produce none at all.

Total: $1,236,600.

The seller nets $3,463,400 on a headline price of $5,000,000, before he pays off a dollar of mortgage.

Why the number surprises people.

Three reasons, and I hear all three regularly.

The first is that sellers think in terms of one rate. They have heard "capital gains are 20 percent" and they do the multiplication in their heads on the drive home. Twenty percent of $3,600,000 is $720,000. The actual figure in this example is over $500,000 higher, because three other taxes are stacked on top of the one they were thinking about.

The second is depreciation. Every year of the hold, depreciation reduced taxable income and felt like a benefit. At sale it reverses, and it reverses at a higher rate than the rest of the gain. Nobody sends you a statement tracking that balance.

The third is state treatment. I once built a projection for a client using the top marginal state rate and had to correct it to a blended calculation. The blended figure was lower, and I would rather show a client the right number than a dramatic one. But blended or top, the state is at the table.

The part that matters.

Every figure above was knowable before the property was listed.

The purchase price is a fact. The depreciation schedule is a fact. The commission is negotiated in advance. The rates are published. There is no forecasting in any of it, no assumption about where the market goes, no supposition of any kind. The tax outcome of a conventional sale is fully determined by information the seller already has in a filing cabinet.

That is the strange thing about this work. A property pro forma is built on estimates. A tax projection is built on facts. And yet almost every seller I meet has spent months on the pro forma and about ten minutes on the tax.

What to do with this.

Run your own version of the arithmetic above. Use your actual basis, your actual depreciation, your actual state. If you do not know your adjusted basis, that alone is worth a phone call to your CPA this week.

Then look at the two numbers side by side. The price, and what reaches you.

If the distance between them is acceptable to you, that is a legitimate answer and you should proceed with confidence. A great many transactions do not need anything more than what a good CPA and a good attorney already provide.

If the distance is not acceptable, you have a decision to make, and you have to make it before you sign. A TaxWealth Tax Analysis™ profiles the federal and state taxes triggered by the sale and compares the outcome with no proactive planning against the outcome that planning can provide. It is a comparison, not a promise. Sometimes the honest result is that nothing changes.

But you cannot decide what you have never calculated.

This information is general and is not tax, legal, or investment advice. The figures above are illustrative and use one set of assumed facts. Every situation is different. Work with your own CPA and attorney before acting on any strategy.