Selling rental condo - capital gains even though selling at same price??

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avenger
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Selling rental condo - capital gains even though selling at same price??

Post by avenger »

I purchased a condominium in 2005 for $170,000.

I put the condo into rental service in 2011, when its fair market value was assessed at $80,000. Therefore, this is my cost basis.

I am about to sell my condo for likely $170,000.

Do I really have a capital gain of $90,000? I have a feeling the answer is yes, but is unbelievably cruel.

Mark
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quantAndHold
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Re: Selling rental condo - capital gains even though selling at same price??

Post by quantAndHold »

Your cost basis is the purchase price + improvements - depreciation. And you subtract out any selling costs (like real estate commission) from the sale price. So in a scenario like this, assuming you haven't done any improvements, you'd pay capital gains on depreciation - selling costs.

So, basically, you're paying capital gains on the depreciation you've been taking.
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Meg77
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Re: Selling rental condo - capital gains even though selling at same price??

Post by Meg77 »

I'm not sure your figures are correct. I'm in a similar situation in that I sold a condo in 2016 that was my homestead from 2009-2014; then I converted it to a rental for three years 2014-2016. I'm trying to figure out the tax implications as well, so I'm not an expert on this. But I do know that part of the answer will depend largely on whether you started depreciating the condo annually while it was a rental. I did, and therefore my cost basis dropped a little bit each year - and therefore part of my "gain" is actually depreciation recapture which is treated differently than a regular capital gain.

Also I'm not sure you can just take the market value at the time of conversion and call that your cost basis. Maybe you can, but you'd have to have a good reason and a solid verification for that. In most cases real estate appreciates over time, so letting you take the value of the home at the time of conversion would benefit most taxpayers (and I hope for my sake that's allowable!). In your case though since the value plunged, using the original value/cost would certainly be preferable, which I believe is an option if not the standard. So I'd look into that.

The bottom line is that your gain may be even larger than you think if you've been depreciating the condo. You'd have a $90K gain (less selling costs, less any capitalized improvements), but your actual basis may be even less than $80K if that was in fact the starting basis. The difference would be all the depreciation you've taken to date, which is taxed at a 25% rate.

This kind of gain would make me consider a 1031 exchange, if you are interested in having rental properties on an ongoing basis.
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Re: Selling rental condo - capital gains even though selling at same price??

Post by avenger »

quantAndHold wrote:Your cost basis is the purchase price + improvements - depreciation. And you subtract out any selling costs (like real estate commission) from the sale price. So in a scenario like this, assuming you haven't done any improvements, you'd pay capital gains on depreciation - selling costs.

So, basically, you're paying capital gains on the depreciation you've been taking.
I'm not sure I made myself clear.

The IRS requires you enter the fair market value when the rental real estate is put into service. That is why my cost basis is so low. I begin renting the condo at the bottom of the market.

My passive losses, including depreciation have been carried over year after year as my income is too high. So there is really no depreciation recapture.
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Re: Selling rental condo - capital gains even though selling at same price??

Post by avenger »

Meg77 wrote:I'm not sure your figures are correct. I'm in a similar situation in that I sold a condo in 2016 that was my homestead from 2009-2014; then I converted it to a rental for three years 2014-2016. I'm trying to figure out the tax implications as well, so I'm not an expert on this. But I do know that part of the answer will depend largely on whether you started depreciating the condo annually while it was a rental. I did, and therefore my cost basis dropped a little bit each year - and therefore part of my "gain" is actually depreciation recapture which is treated differently than a regular capital gain.

Also I'm not sure you can just take the market value at the time of conversion and call that your cost basis. Maybe you can, but you'd have to have a good reason and a solid verification for that. In most cases real estate appreciates over time, so letting you take the value of the home at the time of conversion would benefit most taxpayers (and I hope for my sake that's allowable!). In your case though since the value plunged, using the original value/cost would certainly be preferable, which I believe is an option if not the standard. So I'd look into that.

The bottom line is that your gain may be even larger than you think if you've been depreciating the condo. You'd have a $90K gain (less selling costs, less any capitalized improvements), but your actual basis may be even less than $80K if that was in fact the starting basis. The difference would be all the depreciation you've taken to date, which is taxed at a 25% rate.

This kind of gain would make me consider a 1031 exchange, if you are interested in having rental properties on an ongoing basis.
My accountant told me absolutely you need an appraisal to document fair market value on the date that you put into service. That is the value which is used to calculate your cost basis on the date you convert it from personal use to rental. I obtained an appraisal backdated to the date I put it into service.

See my post above where I mentioned I have been depreciating the condo, but the losses have been disallowed and carried forward.
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Meg77
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Re: Selling rental condo - capital gains even though selling at same price??

Post by Meg77 »

avenger wrote:
quantAndHold wrote:Your cost basis is the purchase price + improvements - depreciation. And you subtract out any selling costs (like real estate commission) from the sale price. So in a scenario like this, assuming you haven't done any improvements, you'd pay capital gains on depreciation - selling costs.

So, basically, you're paying capital gains on the depreciation you've been taking.
I'm not sure I made myself clear.

The IRS requires you enter the fair market value when the rental real estate is put into service. That is why my cost basis is so low. I begin renting the condo at the bottom of the market.

My passive losses, including depreciation have been carried over year after year as my income is too high. So there is really no depreciation recapture.
You're right that effectively you won't pay depreciation recapture since it will be offset by your accumulated rental losses, which are all recognized in the year of sale. It sounds like additional losses (assuming you had losses beyond just depreciation, as many investors do) could offset additional earned income as well, dampening the pain of the capital gain tax.

Bummer. Seems you do have quite a large gain. But hey, at least the value came back up, which is presumably the reason you held the condo rather than selling it for $80K when you moved.
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Re: Selling rental condo - capital gains even though selling at same price??

Post by tj »

This doesnt sound right to me.

I understand that you need to use fmv as the basis for your rental depreciation calculation, but you dont just ignore your initial investment when you sell the asset. Two seperate things.

See link re when selling a converted residence you use original basis.:

http://www.thetaxadviser.com/issues/200 ... perty.html
Last edited by tj on Sat Feb 11, 2017 9:58 am, edited 1 time in total.
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Re: Selling rental condo - capital gains even though selling at same price??

Post by avenger »

tj wrote:This doesnt sound right to me.

I understand that you need to use fmv as the basis for your rental depreciation calculation, but you dont just ignore your initial investment when you sell the asset. Two seperate things.
It didn't "sound right" to me either. However, when I modeled the sale in my tax software that is exactly how it was resulted.

Do you have any further comment? Would greatly appreciate help from anyone who has a good knowledge of this.
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Re: Selling rental condo - capital gains even though selling at same price??

Post by avenger »

Meg77 wrote:
avenger wrote:
quantAndHold wrote:Your cost basis is the purchase price + improvements - depreciation. And you subtract out any selling costs (like real estate commission) from the sale price. So in a scenario like this, assuming you haven't done any improvements, you'd pay capital gains on depreciation - selling costs.

So, basically, you're paying capital gains on the depreciation you've been taking.
I'm not sure I made myself clear.

The IRS requires you enter the fair market value when the rental real estate is put into service. That is why my cost basis is so low. I begin renting the condo at the bottom of the market.

My passive losses, including depreciation have been carried over year after year as my income is too high. So there is really no depreciation recapture.
You're right that effectively you won't pay depreciation recapture since it will be offset by your accumulated rental losses, which are all recognized in the year of sale. It sounds like additional losses (assuming you had losses beyond just depreciation, as many investors do) could offset additional earned income as well, dampening the pain of the capital gain tax.

Bummer. Seems you do have quite a large gain. But hey, at least the value came back up, which is presumably the reason you held the condo rather than selling it for $80K when you moved.
Yeah. Obviously paying taxes is a good problem to have. Just seems a little off to me. Oh well.
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tj
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Re: Selling rental condo - capital gains even though selling at same price??

Post by tj »

avenger wrote:
tj wrote:This doesnt sound right to me.

I understand that you need to use fmv as the basis for your rental depreciation calculation, but you dont just ignore your initial investment when you sell the asset. Two seperate things.
It didn't "sound right" to me either. However, when I modeled the sale in my tax software that is exactly how it was resulted.

Do you have any further comment? Would greatly appreciate help from anyone who has a good knowledge of this.
Further comment would be to read the relevant irs publications if unsure. The software can only outpit what you input. Per the link above, it sounds like it is incorrect.
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Re: Selling rental condo - capital gains even though selling at same price??

Post by Cuzz35 »

Your basis for determining gain is $170k (plus improvements) minus depreciation. Your basis for determining loss is $80k (plus improvements) minus depreciation. Sounds like you will only have some gain related to depreciation recapture.

A sales price between these points results in no gain or lose.

See these prior threads on the discussion.

viewtopic.php?f=2&t=188470&p=2859997#p2859997

viewtopic.php?f=2&t=190355&p=2889380#p2889380

Also max rate on 1250 recapture is 25%.

Hope this helps.
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Re: Selling rental condo - capital gains even though selling at same price??

Post by avenger »

Cuzz35 wrote:Your basis for determining gain is $170k (plus improvements) minus depreciation. Your basis for determining loss is $80k (plus improvements) minus depreciation. Sounds like you will only have some gain related to depreciation recapture.

A sales price between these points results in no gain or lose.

See these prior threads on the discussion.

viewtopic.php?f=2&t=188470&p=2859997#p2859997

viewtopic.php?f=2&t=190355&p=2889380#p2889380

Also max rate on 1250 recapture is 25%.

Hope this helps.
Thank you. Very helpful.
cheers ... -Mark | "Our life is frittered away with detail. Simplify. Simplify." -Henry David Thoreau | [VTI, VXUS, BND, VTEB, SV fund]
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Re: Selling rental condo - capital gains even though selling at same price??

Post by JGoneRiding »

avenger wrote:
tj wrote:This doesnt sound right to me.

I understand that you need to use fmv as the basis for your rental depreciation calculation, but you dont just ignore your initial investment when you sell the asset. Two seperate things.
It didn't "sound right" to me either. However, when I modeled the sale in my tax software that is exactly how it was resulted.

Do you have any further comment? Would greatly appreciate help from anyone who has a good knowledge of this.
your tax software is wrong. read the link provided. most likely you will need an accountant. its because you don't pay taxes on paper losses.

The FMV at time of rental service is used to a) figure out depreciation b) figure out gains. you have no gain
Not Law
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Re: Selling rental condo - capital gains even though selling at same price??

Post by Not Law »

Depreciation is not a choice. Even if you do not claim it as a tax benefit, the IRS assumes you did in calculating recapture.
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Re: Selling rental condo - capital gains even though selling at same price??

Post by avenger »

Not Law wrote:Depreciation is not a choice. Even if you do not claim it as a tax benefit, the IRS assumes you did in calculating recapture.
Correct. That wasn't my question, however. The question was answered by Cuzz35.
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Re: Selling rental condo - capital gains even though selling at same price??

Post by an_asker »

Cuzz35 wrote:Your basis for determining gain is $170k (plus improvements) minus depreciation. Your basis for determining loss is $80k (plus improvements) minus depreciation. Sounds like you will only have some gain related to depreciation recapture.

A sales price between these points results in no gain or lose.

See these prior threads on the discussion.

viewtopic.php?f=2&t=188470&p=2859997#p2859997

viewtopic.php?f=2&t=190355&p=2889380#p2889380

Also max rate on 1250 recapture is 25%.

Hope this helps.
Cuzz35:

You are right of course, but one of the threads you linked above (the first one) has clutchied (sp?) replying at the end of the thread and his/her response is incorrect.

Also, doesn't the cost basis (in both calculations) also include the commissions paid (f any) and taxes etc? Or are those line items that are ignored?

One more thing I am unsure about is whether any paperwork needs to be filed at all (I think not, but not sure) in the case of no-loss no-gain like OP in this situation?
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Re: Selling rental condo - capital gains even though selling at same price??

Post by Cuzz35 »

an_asker wrote:
Cuzz35 wrote:Your basis for determining gain is $170k (plus improvements) minus depreciation. Your basis for determining loss is $80k (plus improvements) minus depreciation. Sounds like you will only have some gain related to depreciation recapture.

A sales price between these points results in no gain or lose.

See these prior threads on the discussion.

viewtopic.php?f=2&t=188470&p=2859997#p2859997

viewtopic.php?f=2&t=190355&p=2889380#p2889380

Also max rate on 1250 recapture is 25%.

Hope this helps.
Cuzz35:

You are right of course, but one of the threads you linked above (the first one) has clutchied (sp?) replying at the end of the thread and his/her response is incorrect.

Also, doesn't the cost basis (in both calculations) also include the commissions paid (f any) and taxes etc? Or are those line items that are ignored?

One more thing I am unsure about is whether any paperwork needs to be filed at all (I think not, but not sure) in the case of no-loss no-gain like OP in this situation?
Selling costs would increase your basis in both calculations. You don't ignore them. Real Estate taxes usually aren't selling costs but are deductible expenses. Sometimes you can capitalize real estate taxes if you make an election and the property is unimproved land.

If you have no gain or loss you may not have to report the sale if the sale was not reported to the IRS. You should receive a 1099-S if it was. However even if you don't receive a 1099-S, I would encourage you to report it anyway.
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Re: Selling rental condo - capital gains even though selling at same price??

Post by casualflower »

If cap gains was only based on the value of the service date, then a you could buy a property for 200K, live in it for 30 years as it appreciates to 1M, convert it, and sell a year later at 1.05M, paying gains on 50K instead of 850K!
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Re: Selling rental condo - capital gains even though selling at same price??

Post by an_asker »

metrunt wrote:If cap gains was only based on the value of the service date, then a you could buy a property for 200K, live in it for 30 years as it appreciates to 1M, convert it, and sell a year later at 1.05M, paying gains on 50K instead of 850K!
There is a reason you cannot do it (or at least that's my understanding), but I cannot quote the law on it. Anyone??
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Re: Selling rental condo - capital gains even though selling at same price??

Post by EATaxGuy »

The depreciable basis of a personal property converted to rental use is the lesser of cost basis or FMV on the date of conversion.
https://www.irs.gov/publications/p527/c ... 1000219151

You should report the sale of the property on form 4797.

If you have suspended passive losses you can take these in the year of the sale and they are deducted at regular income tax rates. Unrecaptured section 1250 gains (a.k.a. depreciation recapture) are taxed at regular income tax rates, but capped at 25% (in reality most people just pay 25%) - NOT capital gains rates.

Capital gains on the property are taxed at capital gains rates. :sharebeer
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Re: Selling rental condo - capital gains even though selling at same price??

Post by EATaxGuy »

EATaxGuy wrote: If you have suspended passive losses you can take these in the year of the sale and they are deducted at regular income tax rates. Unrecaptured section 1250 gains (a.k.a. depreciation recapture) are taxed at regular income tax rates, but capped at 25% (in reality most people just pay 25%) - NOT capital gains rates.
I bring this up because I have had clients get a nice little tax arbitrage out of this situation. They took their suspended passive losses (which were comprised largely of depreciation expense) at their top marginal rate (33%) and then had to pay tax on the depreciation recapture at just 25%. Take money out of the left pocket and get a 33% tax break, then stick in the right pocket and pay 25% tax on it. God Bless America!
You may have been handed a cactus, but sitting on it is up to you.
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Re: Selling rental condo - capital gains even though selling at same price??

Post by casualflower »

an_asker wrote:
metrunt wrote:If cap gains was only based on the value of the service date, then a you could buy a property for 200K, live in it for 30 years as it appreciates to 1M, convert it, and sell a year later at 1.05M, paying gains on 50K instead of 850K!
There is a reason you cannot do it (or at least that's my understanding), but I cannot quote the law on it. Anyone??
Oh, no, you can't do that. The cap gains is based on the purchase date, not the service date. I was just pointing out that if it were based on the service date, there would be a lot of tax avoidance going on (rather than unfair taxation in the OP's situation).
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Re: Selling rental condo - capital gains even though selling at same price??

Post by an_asker »

metrunt wrote:
an_asker wrote:
metrunt wrote:If cap gains was only based on the value of the service date, then a you could buy a property for 200K, live in it for 30 years as it appreciates to 1M, convert it, and sell a year later at 1.05M, paying gains on 50K instead of 850K!
There is a reason you cannot do it (or at least that's my understanding), but I cannot quote the law on it. Anyone??
Oh, no, you can't do that. The cap gains is based on the purchase date, not the service date. I was just pointing out that if it were based on the service date, there would be a lot of tax avoidance going on (rather than unfair taxation in the OP's situation).
Sorry, I misread your quote, so please scratch my previous answer.

Amended response: You should really be able to avoid taxes on $500,000 of capital gains if you live in the house for 30 years, convert it and sell it a year later - because you have used it as your primary residence for at least two out of the last five years.

Now, my previous response was for the opposite situation: if you had it as a rental for a while, then moved back and lived for three years as your primary residence, then sold it. You wouldn't be able to avoid taxes on the $500,000 capital gains - I forget why, but someone mentioned that this is not permissible.
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Re: Selling rental condo - capital gains even though selling at same price??

Post by an_asker »

EATaxGuy wrote:The depreciable basis of a personal property converted to rental use is the lesser of cost basis or FMV on the date of conversion.
https://www.irs.gov/publications/p527/c ... 1000219151
Agreed. However, to determine whether there is a profit/gain, the original purchase price is used like Cuzz pointed out.
EATaxGuy wrote:You should report the sale of the property on form 4797.

If you have suspended passive losses you can take these in the year of the sale and they are deducted at regular income tax rates. Unrecaptured section 1250 gains (a.k.a. depreciation recapture) are taxed at regular income tax rates, but capped at 25% (in reality most people just pay 25%) - NOT capital gains rates.

Capital gains on the property are taxed at capital gains rates. :sharebeer
In the case of OP, there should be no taxes.
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Re: Selling rental condo - capital gains even though selling at same price??

Post by airahcaz »

Apologies for bumping different threads, but there are different responders and wanted to understand how each person resolved their situation.

Given what pub523 states here, if one qualifies for all exclusion criteria, namely no gain and selling a residence converted to a rental at a loss, then a 4797 need NOT be filed?

Determine whether you need to report the gain from
your home. You need to report the gain if ANY of the following
is true.
  • You have taxable gain on your home sale (or on the
    residential portion of your property if you made separate
    calculations for home and business) and don’t
    qualify to exclude all of the gain.
  • You received a Form 1099-S. If so, you must report
    the sale even if you have no taxable gain to report.
  • You wish to report your gain as a taxable gain even
    though some or all of it is eligible for exclusion. You
    may wish to do this if, for example, you plan to sell another
    main home within the next two years and are
    likely to receive a larger gain from the sale of that
    property. If you choose to report, rather than exclude,
    your taxable gain, you can undo that choice by filing
    an amended return within 3 years of the due date of
    your return for the year of the sale, excluding extensions.
If NONE of the three bullets above is true, you don’t
need to report your home sale on your tax return.
If you
didn’t make separate home and business calculations on
your property, skip to Reporting Deductions Related to
Your Home Sale, later.
1) Invest you must 2) Time is your friend 3) Impulse is your enemy 4) Basic arithmetic works 5) Stick to simplicity 6) Stay the course. (Plagiarized, but worth stealing)
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