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Rental Property Sale - Tax Implications

Posted: Fri Feb 09, 2018 9:27 pm
by JI0124
We sold a rental property last year which had been our primary residence before. I know that there are many other threads on this topic and often the advice is to seek the assistance of a tax professional, which I may ultimately do. I will also complete the IRS publication 523 worksheets to see what I come up with. However, I wanted to see if someone could give a quick "directional" take based on the information below.

Original purchase price: $142,500
Original purchase date: March, 2003 (primary residence until conversion to rental)
Converted to rental in April, 2013
Basis at time of conversion: $90,000 (based on comparable sales at that time)
Property was rented from April 2013 - July 2017
Property was sold in August 2017
Sale amount: $118,000

I'm entering information into my tax software but I don't think it's asking me the correct questions - I'm getting some strange results. Based on the above should I expect a capital gain tax and/or tax on depreciation recapture?

Re: Rental Property Sale - Tax Implications

Posted: Sat Feb 10, 2018 8:00 am
by Two Headed Mule
My guess is that the part that is confusing you is the applicable basis issue. Because you converted to rental when the fmv of the property was less than the original purchase price, there are actually two different bases to keep track of. The 90k basis is only used to figure any loss from the sale of the property. To figure gain, the original basis is used. As an example:

Purchase price: 140k
Fmv at conversion to rental: 90k
Depreciation taken: 60k
Sale price August 2017: 120k

Basis for loss = 30k (90 - 60). But there is no loss since sale price is 120k.
Basis for gain = 80k (140 - 60). Sale price is 120k, so gain is 40k, which is all recapture.
If sale price were between 30k and 80k, there would be no gain or loss.

My guess, since you didn't hold it as a rental for very long is that the sale price is falling in between the two bases and so there is no gain or loss.

Mule

Re: Rental Property Sale - Tax Implications

Posted: Sun Feb 11, 2018 1:48 pm
by JI0124
Thanks! That's what I was looking for and assume it's relatively good news as I was concerned about having to pay taxes on the "gains" from the sale and the basis at time of conversion to rental would be used. Not sure yet what to do with what you've provided, but validates that something is wrong in the questions/answers exchange in my tax software.

Re: Rental Property Sale - Tax Implications

Posted: Mon Mar 12, 2018 3:36 pm
by JI0124
Hello - update on this situation...

I've enlisted the help of a CPA (referral from friend) to assist with figuring out how to report this. I've run the numbers myself based on what's described in IRS Pub 551, page 10 which deals with Property Changed to Business or Rental Use. This is where the Sale of such property is described and where it states that the basis is different whether figuring a gain or loss.

I've done the calculations and they are similar to what Two Headed Mule outlined earlier in this post, however the allowable depreciation for the period of time that the property was used for business is much less, and so the basis for gain is greater than the Sale price. So, no gain and no loss.

However, CPA is telling me that I need to pay capital gains on recapture of the depreciation. Is this correct? He won't acknowledge IRS Pub 551 or the calculations that I've presented. I feel kind of bad because I’m asking him a lot of questions but it’s frustrating that I can’t get an explanation.

Anyone have suggestions on what to do?

Re: Rental Property Sale - Tax Implications

Posted: Mon Mar 12, 2018 4:28 pm
by Two Headed Mule
He is simply wrong about this, assuming you have calculated the numbers correctly. In the no gain/no loss situation there is no recapture.

Specifically, the definition of Unrecaptured Section 1250 gain in section 1(h)(6) explicitly requires a taxable gain for the recapture provisions to apply:

"The term 'unrecaptured section 1250 gain' means the excess (if any) of -- (i) the amount of long-term capital gain (not otherwise treated as ordinary income) which would be treated as ordinary income if section 1250(b)(1) included all depreciation...". There is then a denominator which is irrelevant.

Since there is no existing "long term capital gain" from the sale (as already calculated, there is no gain or loss), the Unrecaptured Section 1250 gain amount is definitionally 0. Assuming reference to the rules doesn't sway him, find someone else.

Mule

Re: Rental Property Sale - Tax Implications

Posted: Mon Mar 12, 2018 4:36 pm
by JI0124
Thanks again Mule. Sounds like my hunch is right and I will find someone else!

Re: Rental Property Sale - Tax Implications

Posted: Mon Mar 12, 2018 4:45 pm
by Tal-
Two Headed Mule wrote:
Mon Mar 12, 2018 4:28 pm
He is simply wrong about this, assuming you have calculated the numbers correctly. In the no gain/no loss situation there is no recapture.

Specifically, the definition of Unrecaptured Section 1250 gain in section 1(h)(6) explicitly requires a taxable gain for the recapture provisions to apply:

"The term 'unrecaptured section 1250 gain' means the excess (if any) of -- (i) the amount of long-term capital gain (not otherwise treated as ordinary income) which would be treated as ordinary income if section 1250(b)(1) included all depreciation...". There is then a denominator which is irrelevant.

Since there is no existing "long term capital gain" from the sale (as already calculated, there is no gain or loss), the Unrecaptured Section 1250 gain amount is definitionally 0. Assuming reference to the rules doesn't sway him, find someone else.

Mule
Mule - thanks for the info! This is helpful!!!

Re: Rental Property Sale - Tax Implications

Posted: Mon Mar 12, 2018 5:09 pm
by RetiredTrvl
This is an interesting thread. I have always been told that there was no way around paying the 25% due on depreciation recapture (and what I could research myself online seemed to confirm this - even if you have lived in the property as a primary residence for 2 of the last 5 years before the sale).

I am curious as to how there is no long term gain on the sale as that seems to be the reason why no taxes are due on the depreciation recapture (as well as the only way to avoid it). It looks like there was a gain of 40K in Mule's example.
Two Headed Mule wrote:
Sat Feb 10, 2018 8:00 am

Purchase price: 140k
Fmv at conversion to rental: 90k
Depreciation taken: 60k
Sale price August 2017: 120k

Basis for loss = 30k (90 - 60). But there is no loss since sale price is 120k.
Basis for gain = 80k (140 - 60). Sale price is 120k, so gain is 40k, which is all recapture.
If sale price were between 30k and 80k, there would be no gain or loss.

Re: Rental Property Sale - Tax Implications

Posted: Mon Mar 12, 2018 6:54 pm
by JI0124
This is an interesting thread. I have always been told that there was no way around paying the 25% due on depreciation recapture (and what I could research myself online seemed to confirm this - even if you have lived in the property as a primary residence for 2 of the last 5 years before the sale).

I am curious as to how there is no long term gain on the sale as that seems to be the reason why no taxes are due on the depreciation recapture (as well as the only way to avoid it). It looks like there was a gain of 40K in Mule's example.
The difference in the example that Mule wrote up and my specific scenario is that the depreciation was only about $10,000. So in reality my situation looks more like the below:

Purchase price: 140k
Fmv at conversion to rental: 90k
Depreciation taken: 10k
Sale price August 2017: 120k

Basis for loss = 80k (90 - 10). But there is no loss since sale price is 120k.
Basis for gain = 130k (140 - 10). Sale price is 120k, so gain is -10K. So there is no gain.