Borrowing Money on House Prior to Sale

[Randy123]

What is the name of your state? California

A coworker of mine is selling his house, and is taking out a substantial loan on the property before he sells it. He claims that he can get away without having to pay tax on the money that he received from the loan. At the time of sale, that loan will be paid off from the proceeds. He claims because of the loan payoff, that effectively lowers the amount of his profit from the sale, and therefore the tax he owes. I don't think this is correct, as he has pulled profit out of the property, prior to the sale, via this loan. My feeling is that this would raise red flag with the IRS. This can't be a legal practice, is it?

 

[Snipes5]

Probably not illegal, but amazingly stupid.

The amount owed to creditors has no relation to the amount of profit one makes on the sale of property.

Profit is determined by subtracting the basis (purchase price plus improvements) from the selling price.

If he owes most of the profit to a bank, he'll receive less cash at closing, but will owe the same amount of capital gains.

Not only that, he will probably have to pay loan fees to borrow against the house to begin with.

I'd hate to be his tax preparer.

Snipes

 

[Randy123]

He claims that the amount of the loan would reduce the amount of $ that capital gains would be taxed on.

 

[Snipes5]

He can claim whatever he likes, but that still makes him an idiot, and doesn't change the amount of capital gains he will owe, which is calculated as I indicated above.

Snipes

 

[gaboy]

This does not make sense. The personal exemption is so high right now, why would he even need to do this. It must be he has debt he has to clear up as a condition of the mortgage for his new home.