Tax question - California depreciation recapture

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fyre4ce
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Tax question - California depreciation recapture

Post by fyre4ce » Fri Jan 10, 2020 4:57 pm

About to sell a rental property that was a former primary home, and that qualifies for the home sale exclusion. Purchased in early 2012 and expect to sell this month. Property is located in Texas.

Property was depreciated roughly $6,000/year in 2012-2019, and probably a tiny bit in 2020, so let's say $48,000. In 2012, 2013, and part of 2014 I lived and worked in Texas, so no California taxes. Mid-2014 thru mid-2016 I was working in California (and filing California income taxes) but the home was still the primary residence. Mid-2016 thru today, property was a full-time rental with me living and working in California.

Question: when the property is sold, am I allowed to exclude ~$15,000 of depreciation recapture from California state taxes for the time I owned the property and lived/worked out of state, on the basis that this depreciation was taken at a time when I didn't file California taxes and thus never got a deduction? Thanks in advance.

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grabiner
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Re: Tax question - California depreciation recapture

Post by grabiner » Fri Jan 10, 2020 11:07 pm

The state tax will be based on CA tax law as if you had always been a resident. (If you had filed a CA tax form while a CA non-resident, you would have reported the depreciation on your CA tax form). You pay CA tax on the entire capital gain, not just the amount of gain earned while you were a CA resident. This is fair in the other direction as well; if you had moved out of CA, you would have deducted depreciation while a CA resident, but CA would not tax the capital gain at all.

For similar reasons, if you contributed to an IRA while a non-CA resident, and your contributions were federally deductible, you pay CA tax on the entire withdrawal as a CA resident, and you do not pay any tax to the state where you lived when you deducted the contribution. (This can also work to your advantage. If you contributed to an IRA while a non-NJ resident, and deducted the contribution from your non-NJ state tax, you do not pay NJ tax on the contributed amount. because NJ does not allow deductions for IRA contributions.)

The relevant reference is CA FTB Publication 1100; it doesn't deal specifically with this case, but it has other examples which cover similar issues.

(edited to correct publication number)
Last edited by grabiner on Sat Jan 11, 2020 4:10 pm, edited 1 time in total.
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MarkNYC
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Re: Tax question - California depreciation recapture

Post by MarkNYC » Sat Jan 11, 2020 9:21 am

fyre4ce wrote:
Fri Jan 10, 2020 4:57 pm
About to sell a rental property that was a former primary home, and that qualifies for the home sale exclusion. Purchased in early 2012 and expect to sell this month. Property is located in Texas.

Property was depreciated roughly $6,000/year in 2012-2019, and probably a tiny bit in 2020, so let's say $48,000. In 2012, 2013, and part of 2014 I lived and worked in Texas, so no California taxes. Mid-2014 thru mid-2016 I was working in California (and filing California income taxes) but the home was still the primary residence. Mid-2016 thru today, property was a full-time rental with me living and working in California.
Two questions:
1. Why was the property depreciated $6,000/year for 8 years when it was a principal residence for about 5 of those years?
2. The principal residence exclusion requires use as a principal residence for at least 2 of the 5 years prior to the date of sale. If it became a full-time rental in mid-2016, why do you think it will qualify for the exclusion when sold in Jan 2020?

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Re: Tax question - California depreciation recapture

Post by fyre4ce » Sat Jan 11, 2020 10:21 pm

MarkNYC wrote:
Sat Jan 11, 2020 9:21 am
fyre4ce wrote:
Fri Jan 10, 2020 4:57 pm
About to sell a rental property that was a former primary home, and that qualifies for the home sale exclusion. Purchased in early 2012 and expect to sell this month. Property is located in Texas.

Property was depreciated roughly $6,000/year in 2012-2019, and probably a tiny bit in 2020, so let's say $48,000. In 2012, 2013, and part of 2014 I lived and worked in Texas, so no California taxes. Mid-2014 thru mid-2016 I was working in California (and filing California income taxes) but the home was still the primary residence. Mid-2016 thru today, property was a full-time rental with me living and working in California.
Two questions:
1. Why was the property depreciated $6,000/year for 8 years when it was a principal residence for about 5 of those years?
2. The principal residence exclusion requires use as a principal residence for at least 2 of the 5 years prior to the date of sale. If it became a full-time rental in mid-2016, why do you think it will qualify for the exclusion when sold in Jan 2020?
1. I had paying roommates since shortly after buying it.

2. The exclusion gets phased out based on the number of months of owner occupancy in the last 5 years. My exclusion will be $500k x (~18/24) = ~$375k and I have only ~$150k of gain. The law, I believe, allows 100% exclusion under the adjusted amount, rather than scaling the exclusion to (N/24) x actual gain.

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Re: Tax question - California depreciation recapture

Post by MarkNYC » Sun Jan 12, 2020 9:53 am

fyre4ce wrote:
Sat Jan 11, 2020 10:21 pm
MarkNYC wrote:
Sat Jan 11, 2020 9:21 am
fyre4ce wrote:
Fri Jan 10, 2020 4:57 pm
About to sell a rental property that was a former primary home, and that qualifies for the home sale exclusion. Purchased in early 2012 and expect to sell this month. Property is located in Texas.

Property was depreciated roughly $6,000/year in 2012-2019, and probably a tiny bit in 2020, so let's say $48,000. In 2012, 2013, and part of 2014 I lived and worked in Texas, so no California taxes. Mid-2014 thru mid-2016 I was working in California (and filing California income taxes) but the home was still the primary residence. Mid-2016 thru today, property was a full-time rental with me living and working in California.
Two questions:
1. Why was the property depreciated $6,000/year for 8 years when it was a principal residence for about 5 of those years?
2. The principal residence exclusion requires use as a principal residence for at least 2 of the 5 years prior to the date of sale. If it became a full-time rental in mid-2016, why do you think it will qualify for the exclusion when sold in Jan 2020?
1. I had paying roommates since shortly after buying it.

2. The exclusion gets phased out based on the number of months of owner occupancy in the last 5 years. My exclusion will be $500k x (~18/24) = ~$375k and I have only ~$150k of gain. The law, I believe, allows 100% exclusion under the adjusted amount, rather than scaling the exclusion to (N/24) x actual gain.
You may have a couple of potential problems related to the exclusion.

First, a partial exclusion is allowed only if the primary reason for selling is a qualifying change in circumstance. It was intended to give some relief to someone who bought a home and had to sell prior to meeting the 2-year ownership and use requirement. A change of employment is a qualifying reason, but you may have difficulty claiming that was your primary reason for selling since you waited almost 6 years after changing employment before selling.

Second, it's doubtful you met the principal residence "use" test for the period mid-2014 through mid-2016, when you were living and working in CA. The "use" test allows for temporary absences for certain reasons, but changing employment is not one of them. An absence of more than 12 months is not considered temporary, and your absence starting mid-2014 was permanent, not temporary.

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Re: Tax question - California depreciation recapture

Post by fyre4ce » Sun Jan 12, 2020 12:27 pm

MarkNYC wrote:
Sun Jan 12, 2020 9:53 am
fyre4ce wrote:
Sat Jan 11, 2020 10:21 pm
MarkNYC wrote:
Sat Jan 11, 2020 9:21 am
fyre4ce wrote:
Fri Jan 10, 2020 4:57 pm
About to sell a rental property that was a former primary home, and that qualifies for the home sale exclusion. Purchased in early 2012 and expect to sell this month. Property is located in Texas.

Property was depreciated roughly $6,000/year in 2012-2019, and probably a tiny bit in 2020, so let's say $48,000. In 2012, 2013, and part of 2014 I lived and worked in Texas, so no California taxes. Mid-2014 thru mid-2016 I was working in California (and filing California income taxes) but the home was still the primary residence. Mid-2016 thru today, property was a full-time rental with me living and working in California.
Two questions:
1. Why was the property depreciated $6,000/year for 8 years when it was a principal residence for about 5 of those years?
2. The principal residence exclusion requires use as a principal residence for at least 2 of the 5 years prior to the date of sale. If it became a full-time rental in mid-2016, why do you think it will qualify for the exclusion when sold in Jan 2020?
1. I had paying roommates since shortly after buying it.

2. The exclusion gets phased out based on the number of months of owner occupancy in the last 5 years. My exclusion will be $500k x (~18/24) = ~$375k and I have only ~$150k of gain. The law, I believe, allows 100% exclusion under the adjusted amount, rather than scaling the exclusion to (N/24) x actual gain.
You may have a couple of potential problems related to the exclusion.

First, a partial exclusion is allowed only if the primary reason for selling is a qualifying change in circumstance. It was intended to give some relief to someone who bought a home and had to sell prior to meeting the 2-year ownership and use requirement. A change of employment is a qualifying reason, but you may have difficulty claiming that was your primary reason for selling since you waited almost 6 years after changing employment before selling.

Second, it's doubtful you met the principal residence "use" test for the period mid-2014 through mid-2016, when you were living and working in CA. The "use" test allows for temporary absences for certain reasons, but changing employment is not one of them. An absence of more than 12 months is not considered temporary, and your absence starting mid-2014 was permanent, not temporary.
Without getting into too many specifics, I don’t think either of these should be a problem. There were two job changes in California, one in 2014 and one in 2017, that cemented us more permanently here. By 2017 I already had a tenant, and am selling immediately after they moved out in 2019. Also, for the 2014-2016 period, my spouse lived in the house and I flew back and forth about 3 weeks every month, so it was much more our primary residence than the room I rented in CA.

I agree it’s a grey area but it comfortable calling this one in my favor.

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Re: Tax question - California depreciation recapture

Post by JGoneRiding » Sun Jan 12, 2020 12:34 pm

Did your spouse also own the house? Not clear from your posts since you said you had paying roommates.

You dont get to claim 500k just because your spouse lived there if she wasnt also an owner.

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Re: Tax question - California depreciation recapture

Post by MarkNYC » Sun Jan 12, 2020 1:26 pm

JGoneRiding wrote:
Sun Jan 12, 2020 12:34 pm
Did your spouse also own the house? Not clear from your posts since you said you had paying roommates.

You dont get to claim 500k just because your spouse lived there if she wasnt also an owner.
For the $500k joint exclusion, only one spouse must meet the ownership test, but both spouses must meet the use test.

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Re: Tax question - California depreciation recapture

Post by fyre4ce » Sun Jan 12, 2020 5:43 pm

JGoneRiding wrote:
Sun Jan 12, 2020 12:34 pm
Did your spouse also own the house? Not clear from your posts since you said you had paying roommates.

You dont get to claim 500k just because your spouse lived there if she wasnt also an owner.
Are you sure? I thought only one spouse needs to meet the ownership test.

It wouldn’t matter in this case, because even $250k x 18/24 is more than my actual gain.

EDIT: I took another look at the IRS Pub. It looks like I can probably only claim a partial exclusion of $250k x 18/24, although in my case it will be enough. For MFJ, only one spouse needs to meet the ownership test but both spouses need to meet the use test. If they don't, then the exclusion gets calculated separately for each spouse and the results are added together. The calculation is $250k x N/24, where N is the smallest number of months (up to 24) of ownership, use, or time since the last use of the exclusion. For me, I meet the full ownership test, have ~18 months of use, and have never claimed a prior exclusion, ~$175k. My spouse has ~18 months of use, but no ownership, so $0. Maybe I could make arguments about marriage and community property, helping manage the property etc to claim ownership since marriage, but I'm not sure these would be sound, and in any case, not necessary. I did confirm that I'm allowed to exclude 100% of gains under the exclusion limit, as opposed to it being pro-rated, so it still looks to me like I'll be able to exclude the entire gain.
Last edited by fyre4ce on Mon Jan 13, 2020 2:33 pm, edited 1 time in total.

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Re: Tax question - California depreciation recapture

Post by fyre4ce » Sun Jan 12, 2020 5:46 pm

MarkNYC wrote:
Sun Jan 12, 2020 1:26 pm
JGoneRiding wrote:
Sun Jan 12, 2020 12:34 pm
Did your spouse also own the house? Not clear from your posts since you said you had paying roommates.

You dont get to claim 500k just because your spouse lived there if she wasnt also an owner.
For the $500k joint exclusion, only one spouse must meet the ownership test, but both spouses must meet the use test.
I point out that my spouse lived there to add support to the case that it was my primary home. The irs says they look at the totality of circumstance in determining a primary home and I’d be comfortable defending that in an audit.

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Re: Tax question - California depreciation recapture

Post by fyre4ce » Sun Jan 12, 2020 11:26 pm

grabiner wrote:
Fri Jan 10, 2020 11:07 pm
The state tax will be based on CA tax law as if you had always been a resident. (If you had filed a CA tax form while a CA non-resident, you would have reported the depreciation on your CA tax form). You pay CA tax on the entire capital gain, not just the amount of gain earned while you were a CA resident. This is fair in the other direction as well; if you had moved out of CA, you would have deducted depreciation while a CA resident, but CA would not tax the capital gain at all.

For similar reasons, if you contributed to an IRA while a non-CA resident, and your contributions were federally deductible, you pay CA tax on the entire withdrawal as a CA resident, and you do not pay any tax to the state where you lived when you deducted the contribution. (This can also work to your advantage. If you contributed to an IRA while a non-NJ resident, and deducted the contribution from your non-NJ state tax, you do not pay NJ tax on the contributed amount. because NJ does not allow deductions for IRA contributions.)

The relevant reference is CA FTB Publication 1100; it doesn't deal specifically with this case, but it has other examples which cover similar issues.

(edited to correct publication number)
I understand what you say generally, but depreciation recapture seems a bit different, because it's not a tax on real income, but more like a tax subsidy that is eventually repaid. The link you provided is helpful, but in many cases adjustments are made to total income to calculate CA-taxable income. A simple example is someone moving to CA mid-year - out-of-state income is not taxed. Your point about reciprocity makes a lot of sense, but I was hoping to find a source specifically on depreciation recapture. I know a CPA who owes me a favor; I may ask him.

MarkNYC
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Re: Tax question - California depreciation recapture

Post by MarkNYC » Mon Jan 13, 2020 4:21 pm

fyre4ce wrote:
Sun Jan 12, 2020 5:43 pm

EDIT: I took another look at the IRS Pub. It looks like I can probably only claim a partial exclusion of $250k x 18/24, although in my case it will be enough. For MFJ, only one spouse needs to meet the ownership test but both spouses need to meet the use test. If they don't, then the exclusion gets calculated separately for each spouse and the results are added together. The calculation is $250k x N/24, where N is the smallest number of months (up to 24) of ownership, use, or time since the last use of the exclusion. For me, I meet the full ownership test, have ~18 months of use, and have never claimed a prior exclusion, ~$175k. My spouse has ~18 months of use, but no ownership, so $0. Maybe I could make arguments about marriage and community property, helping manage the property etc to claim ownership since marriage, but I'm not sure these would be sound, and in any case, not necessary. I did confirm that I'm allowed to exclude 100% of gains under the exclusion limit, as opposed to it being pro-rated, so it still looks to me like I'll be able to exclude the entire gain.
Since your original question was about a possible CA adjustment for depreciation, I assumed you were already aware that the portion of the gain attributable to depreciation is not eligible for the exclusion. (you said approximately $48K) So you cannot exclude the entire gain.

hachiko
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Re: Tax question - California depreciation recapture

Post by hachiko » Mon Jan 13, 2020 6:24 pm

fyre4ce wrote:
Sun Jan 12, 2020 11:26 pm
I understand what you say generally, but depreciation recapture seems a bit different, because it's not a tax on real income, but more like a tax subsidy that is eventually repaid. The link you provided is helpful, but in many cases adjustments are made to total income to calculate CA-taxable income. A simple example is someone moving to CA mid-year - out-of-state income is not taxed. Your point about reciprocity makes a lot of sense, but I was hoping to find a source specifically on depreciation recapture. I know a CPA who owes me a favor; I may ask him.
First, I think you should take your CPA up on that (assuming they know CA personal income tax rules). If not, hire someone who does.

Second, I don't really understand what you're trying to say here about depreciation recapture, but I assume it's more of a policy argument you're trying to make. In practice, as a VERY broad overview, most states use your federal income (some version of the income number) and then make statutory modifications. Generally, if there's no specific statutory subtraction, if an item is included in federal income (whatever the definition of federal income that the state uses), then it's included in state taxable income. Because residents are taxed on all income, it would be included.

If you're trying to make a Constitutional claim (California should be disallowed from taxing the depreciation recapture) then you should absolutely consult with someone. I'm not sure about California, but some states require you to provide a statement with your return that you are taking a Constitutional position.

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fyre4ce
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Re: Tax question - California depreciation recapture

Post by fyre4ce » Mon Jan 13, 2020 6:36 pm

MarkNYC wrote:
Mon Jan 13, 2020 4:21 pm
Since your original question was about a possible CA adjustment for depreciation, I assumed you were already aware that the portion of the gain attributable to depreciation is not eligible for the exclusion. (you said approximately $48K) So you cannot exclude the entire gain.
That's correct. I think of depreciation more like an interest-free loan than an actual tax deduction. The difference between the "amount realized" (sale price minus transaction costs) and adjusted basis (purchase price minus depreciation, plus capital improvements) is about $120k. About $48k will be depreciation recapture, which is taxable up to 25%, and another $72k of long-term capital gains, which by my reading of the rules will be tax-free federally and CA.

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Re: Tax question - California depreciation recapture

Post by fyre4ce » Mon Jan 13, 2020 6:51 pm

hachiko wrote:
Mon Jan 13, 2020 6:24 pm
fyre4ce wrote:
Sun Jan 12, 2020 11:26 pm
I understand what you say generally, but depreciation recapture seems a bit different, because it's not a tax on real income, but more like a tax subsidy that is eventually repaid. The link you provided is helpful, but in many cases adjustments are made to total income to calculate CA-taxable income. A simple example is someone moving to CA mid-year - out-of-state income is not taxed. Your point about reciprocity makes a lot of sense, but I was hoping to find a source specifically on depreciation recapture. I know a CPA who owes me a favor; I may ask him.
First, I think you should take your CPA up on that (assuming they know CA personal income tax rules). If not, hire someone who does.

Second, I don't really understand what you're trying to say here about depreciation recapture, but I assume it's more of a policy argument you're trying to make. In practice, as a VERY broad overview, most states use your federal income (some version of the income number) and then make statutory modifications. Generally, if there's no specific statutory subtraction, if an item is included in federal income (whatever the definition of federal income that the state uses), then it's included in state taxable income. Because residents are taxed on all income, it would be included.

If you're trying to make a Constitutional claim (California should be disallowed from taxing the depreciation recapture) then you should absolutely consult with someone. I'm not sure about California, but some states require you to provide a statement with your return that you are taking a Constitutional position.
I think I will consult a CPA, although with the sale being in 2020 I won't have to deal with it for another year. I have a couple other questions too, relating to "improvements" (really repairs, but the IRS categorizes them as improvements) with multi-year depreciation being sold off part-way through their depreciation schedule. I haven't tried to put the transaction into TurboTax yet, but I've found the questions it asks are sometimes helpful too in figuring out how it works.

California has their own separate depreciation schedule and rules that sometimes align with federal rules, and sometimes not. For instance, our 2018 return included CA Form 3885A, Depreciation and Amortization Adjustments. I took accelerated depreciation on a couple items on the federal return that CA doesn't allow. I have separate depreciation amounts already, and two separate passive activity loss carry-forwards for federal and state, so it's not unthinkable to me that depreciation recapture could be California-specific. I may try putting the sale into TurboTax in a fictitious return for 2019 and see what it populates.

I'm not sure what you mean by a "Constitutional" argument, but I don't think that's what what I'm trying to do here.

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Re: Tax question - California depreciation recapture

Post by hachiko » Mon Jan 13, 2020 7:17 pm

fyre4ce wrote:
Mon Jan 13, 2020 6:51 pm
hachiko wrote:
Mon Jan 13, 2020 6:24 pm
fyre4ce wrote:
Sun Jan 12, 2020 11:26 pm
I understand what you say generally, but depreciation recapture seems a bit different, because it's not a tax on real income, but more like a tax subsidy that is eventually repaid. The link you provided is helpful, but in many cases adjustments are made to total income to calculate CA-taxable income. A simple example is someone moving to CA mid-year - out-of-state income is not taxed. Your point about reciprocity makes a lot of sense, but I was hoping to find a source specifically on depreciation recapture. I know a CPA who owes me a favor; I may ask him.
First, I think you should take your CPA up on that (assuming they know CA personal income tax rules). If not, hire someone who does.

Second, I don't really understand what you're trying to say here about depreciation recapture, but I assume it's more of a policy argument you're trying to make. In practice, as a VERY broad overview, most states use your federal income (some version of the income number) and then make statutory modifications. Generally, if there's no specific statutory subtraction, if an item is included in federal income (whatever the definition of federal income that the state uses), then it's included in state taxable income. Because residents are taxed on all income, it would be included.

If you're trying to make a Constitutional claim (California should be disallowed from taxing the depreciation recapture) then you should absolutely consult with someone. I'm not sure about California, but some states require you to provide a statement with your return that you are taking a Constitutional position.
I think I will consult a CPA, although with the sale being in 2020 I won't have to deal with it for another year. I have a couple other questions too, relating to "improvements" (really repairs, but the IRS categorizes them as improvements) with multi-year depreciation being sold off part-way through their depreciation schedule. I haven't tried to put the transaction into TurboTax yet, but I've found the questions it asks are sometimes helpful too in figuring out how it works.

California has their own separate depreciation schedule and rules that sometimes align with federal rules, and sometimes not. For instance, our 2018 return included CA Form 3885A, Depreciation and Amortization Adjustments. I took accelerated depreciation on a couple items on the federal return that CA doesn't allow. I have separate depreciation amounts already, and two separate passive activity loss carry-forwards for federal and state, so it's not unthinkable to me that depreciation recapture could be California-specific. I may try putting the sale into TurboTax in a fictitious return for 2019 and see what it populates.

I'm not sure what you mean by a "Constitutional" argument, but I don't think that's what what I'm trying to do here.
Yes, California has it's own depreciation rules, even more different now after the TCJA because California doesn't conform to many parts of the TCJA. But it seems that this isn't a depreciation question, since there was no depreciation taken in California. If you did take depreciation in California, then it's true that California basis may be different than federal basis.

There may be specific exclusions, accrual rules for individuals who change residency, etc. But generally the structure of the statutory regime is as stated above. Because there are certain situations which fall out of the norm, the statutory structure sometimes fails to match what the answer should be, or even what the legislature may have intended. Which is why I am suggesting you consult with someone who has specific knowledge of California law.

By a Constitutional argument, I mean an argument that "because the property is not located in California and you were not a California resident when the depreciation deductions were taken, California is barred under the (Commerce Clause, Due Process Clause, various clauses of the California Constitution, etc.) In other words "it doesn't matter what the statutes say, California cannot tax the depreciation recapture."

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fyre4ce
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Re: Tax question - California depreciation recapture

Post by fyre4ce » Mon Jan 13, 2020 7:50 pm

hachiko wrote:
Mon Jan 13, 2020 7:17 pm
Yes, California has it's own depreciation rules, even more different now after the TCJA because California doesn't conform to many parts of the TCJA. But it seems that this isn't a depreciation question, since there was no depreciation taken in California. If you did take depreciation in California, then it's true that California basis may be different than federal basis.

There may be specific exclusions, accrual rules for individuals who change residency, etc. But generally the structure of the statutory regime is as stated above. Because there are certain situations which fall out of the norm, the statutory structure sometimes fails to match what the answer should be, or even what the legislature may have intended. Which is why I am suggesting you consult with someone who has specific knowledge of California law.

By a Constitutional argument, I mean an argument that "because the property is not located in California and you were not a California resident when the depreciation deductions were taken, California is barred under the (Commerce Clause, Due Process Clause, various clauses of the California Constitution, etc.) In other words "it doesn't matter what the statutes say, California cannot tax the depreciation recapture."
I definitely did claim some depreciation on the property while a CA resident. Most or all of it was deferred by the passive activity loss limitation, so effectively the CA depreciation comes out in the wash - I have to pay it back in tax year 2020, but I also get to deduct the accumulated loss, and both will be at ordinary income tax rates, so it doesn't matter. What's at issue is the depreciation I took on the federal return for the few years I owned the property but was not a CA resident. None of those deductions were excluded by PALL.

I wouldn't go down the Constitutional route you describe. Not my style (at least for an issue like this) and not worth my time. Although if after consultation with a CPA, we decided the CA tax code was ambiguous, I might just make the adjustment myself and deal with it in an audit if it ever happens.

hachiko
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Re: Tax question - California depreciation recapture

Post by hachiko » Mon Jan 13, 2020 8:53 pm

So this is getting very complex very quickly.

Not saying this is your answer, but just a couple hypotheticals to consider.

If you were a California resident and took depreciation deductions on the Texas property, but then moved to Texas, established a domicile there, and then sold the property, would you have to file a California return and pay tax on the depreciation recapture for the depreciation you took while a California resident?

If a corporation owned the property, in 2017 had $100 in taxable income before depreciation, depreciation was $20, and the California apportionment rate is 50% it's taxable income in California is $40 (essentially getting a $10 benefit from depreciation). Then in 2018 the corporation sells the property for a total gain of $20 and that was its only 2018 income. If the California apportionment factor in 2018 is only 10%, the California taxable income is $2.

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fyre4ce
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Re: Tax question - California depreciation recapture

Post by fyre4ce » Mon Jan 13, 2020 9:48 pm

hachiko wrote:
Mon Jan 13, 2020 8:53 pm
So this is getting very complex very quickly.

Not saying this is your answer, but just a couple hypotheticals to consider.

If you were a California resident and took depreciation deductions on the Texas property, but then moved to Texas, established a domicile there, and then sold the property, would you have to file a California return and pay tax on the depreciation recapture for the depreciation you took while a California resident?

If a corporation owned the property, in 2017 had $100 in taxable income before depreciation, depreciation was $20, and the California apportionment rate is 50% it's taxable income in California is $40 (essentially getting a $10 benefit from depreciation). Then in 2018 the corporation sells the property for a total gain of $20 and that was its only 2018 income. If the California apportionment factor in 2018 is only 10%, the California taxable income is $2.
Agreed that it's complex. Seems to me the easiest solution is for CA to just not offer depreciation (or recapture) on out-of-state properties, although I don't think this is the law because my TurboTax-prepared return from 2018 (full-time CA resident) did seem to take deprecation on the property on the CA return. My assumption is that I wouldn't owe CA deprecation recapture if I moved out of state and sold the property then. Although if the property were in CA, I would owe taxes on the sale even if I were out of state.

hachiko
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Re: Tax question - California depreciation recapture

Post by hachiko » Mon Jan 13, 2020 10:06 pm

fyre4ce wrote:
Mon Jan 13, 2020 9:48 pm
hachiko wrote:
Mon Jan 13, 2020 8:53 pm
So this is getting very complex very quickly.

Not saying this is your answer, but just a couple hypotheticals to consider.

If you were a California resident and took depreciation deductions on the Texas property, but then moved to Texas, established a domicile there, and then sold the property, would you have to file a California return and pay tax on the depreciation recapture for the depreciation you took while a California resident?

If a corporation owned the property, in 2017 had $100 in taxable income before depreciation, depreciation was $20, and the California apportionment rate is 50% it's taxable income in California is $40 (essentially getting a $10 benefit from depreciation). Then in 2018 the corporation sells the property for a total gain of $20 and that was its only 2018 income. If the California apportionment factor in 2018 is only 10%, the California taxable income is $2.
Agreed that it's complex. Seems to me the easiest solution is for CA to just not offer depreciation (or recapture) on out-of-state properties, although I don't think this is the law because my TurboTax-prepared return from 2018 (full-time CA resident) did seem to take deprecation on the property on the CA return.
That would likely be considered unconstitutional. I think there was actually a California case on this question of benefiting in state investment.

MarkNYC
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Re: Tax question - California depreciation recapture

Post by MarkNYC » Mon Jan 13, 2020 11:06 pm

fyre4ce wrote:
Sun Jan 12, 2020 11:26 pm

... but in many cases adjustments are made to total income to calculate CA-taxable income. A simple example is someone moving to CA mid-year - out-of-state income is not taxed. Your point about reciprocity makes a lot of sense, but I was hoping to find a source specifically on depreciation recapture. I know a CPA who owes me a favor; I may ask him.
Your instincts on this one may have been good. Unlike most states, CA allows adjustments, both positive and negative, for specific income and deduction items when the CA amount or law differs from federal. These adjustments are reported on Form CA(540) or CA(540NR).

In the instructions to Form CA(540) it states: "Get FTB Pub. 1001 for more information about...basis adjustments related to property acquired prior to becoming a CA resident." In FTB Pub.1001 Supplemental Guideline to CA Adjustments, in the section on Gains and Losses, in the subsection on Gain on Sale of Principal Residence, it states "if there is difference between the amount excluded (or depreciated if recapture applies) for federal and California, complete CA Schedule D..."

Essentially, your basis is higher for CA than federal, so your CA total gain is less. You should look into it further to ensure your facts coincide with CA law, and for full and proper procedures for correct reporting.

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Re: Tax question - California depreciation recapture

Post by grabiner » Tue Jan 14, 2020 12:01 am

MarkNYC wrote:
Mon Jan 13, 2020 11:06 pm
fyre4ce wrote:
Sun Jan 12, 2020 11:26 pm

... but in many cases adjustments are made to total income to calculate CA-taxable income. A simple example is someone moving to CA mid-year - out-of-state income is not taxed. Your point about reciprocity makes a lot of sense, but I was hoping to find a source specifically on depreciation recapture. I know a CPA who owes me a favor; I may ask him.
Your instincts on this one may have been good. Unlike most states, CA allows adjustments, both positive and negative, for specific income and deduction items when the CA amount or law differs from federal. These adjustments are reported on Form CA(540) or CA(540NR).

In the instructions to Form CA(540) it states: "Get FTB Pub. 1001 for more information about...basis adjustments related to property acquired prior to becoming a CA resident." In FTB Pub.1001 Supplemental Guideline to CA Adjustments, in the section on Gains and Losses, in the subsection on Gain on Sale of Principal Residence, it states "if there is difference between the amount excluded (or depreciated if recapture applies) for federal and California, complete CA Schedule D..."

Essentially, your basis is higher for CA than federal, so your CA total gain is less. You should look into it further to ensure your facts coincide with CA law, and for full and proper procedures for correct reporting.
The publication is not yet available for 2019, but here is the 2018 version

But Publication 1001 doesn't really help with this situation. It says that if you claimed different depreciation under CA and federal law, you adjust on CA Schedule D to report the correct amount. So you need to compute what the depreciation would be under CA law, and adjust accordingly.
Wiki David Grabiner

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Re: Tax question - California depreciation recapture

Post by MarkNYC » Tue Jan 14, 2020 12:24 am

grabiner wrote:
Tue Jan 14, 2020 12:01 am
MarkNYC wrote:
Mon Jan 13, 2020 11:06 pm
fyre4ce wrote:
Sun Jan 12, 2020 11:26 pm

... but in many cases adjustments are made to total income to calculate CA-taxable income. A simple example is someone moving to CA mid-year - out-of-state income is not taxed. Your point about reciprocity makes a lot of sense, but I was hoping to find a source specifically on depreciation recapture. I know a CPA who owes me a favor; I may ask him.
Your instincts on this one may have been good. Unlike most states, CA allows adjustments, both positive and negative, for specific income and deduction items when the CA amount or law differs from federal. These adjustments are reported on Form CA(540) or CA(540NR).

In the instructions to Form CA(540) it states: "Get FTB Pub. 1001 for more information about...basis adjustments related to property acquired prior to becoming a CA resident." In FTB Pub.1001 Supplemental Guideline to CA Adjustments, in the section on Gains and Losses, in the subsection on Gain on Sale of Principal Residence, it states "if there is difference between the amount excluded (or depreciated if recapture applies) for federal and California, complete CA Schedule D..."

Essentially, your basis is higher for CA than federal, so your CA total gain is less. You should look into it further to ensure your facts coincide with CA law, and for full and proper procedures for correct reporting.
The publication is not yet available for 2019, but here is the 2018 version

But Publication 1001 doesn't really help with this situation. It says that if you claimed different depreciation under CA and federal law, you adjust on CA Schedule D to report the correct amount. So you need to compute what the depreciation would be under CA law, and adjust accordingly.
David,
In what specific section/page of 2018 Pub 1001 do you see that instruction?

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Re: Tax question - California depreciation recapture

Post by grabiner » Tue Jan 14, 2020 9:07 am

MarkNYC wrote:
Tue Jan 14, 2020 12:24 am
grabiner wrote:
Tue Jan 14, 2020 12:01 am
MarkNYC wrote:
Mon Jan 13, 2020 11:06 pm
In the instructions to Form CA(540) it states: "Get FTB Pub. 1001 for more information about...basis adjustments related to property acquired prior to becoming a CA resident." In FTB Pub.1001 Supplemental Guideline to CA Adjustments, in the section on Gains and Losses, in the subsection on Gain on Sale of Principal Residence, it states "if there is difference between the amount excluded (or depreciated if recapture applies) for federal and California, complete CA Schedule D..."

Essentially, your basis is higher for CA than federal, so your CA total gain is less. You should look into it further to ensure your facts coincide with CA law, and for full and proper procedures for correct reporting.
The publication is not yet available for 2019, but here is the 2018 version

But Publication 1001 doesn't really help with this situation. It says that if you claimed different depreciation under CA and federal law, you adjust on CA Schedule D to report the correct amount. So you need to compute what the depreciation would be under CA law, and adjust accordingly.
David,
In what specific section/page of 2018 Pub 1001 do you see that instruction?
Just the section you quoted; my comment was about the lack of any other guidance. "If there is difference between the amount... depreciated if recapture applies, complete CA Schedule D." This says nothing about why there might be a difference in depreciation, so you have to look elsewhere in the CA laws, such as differences between federal and CA depreciation rules for past years, to see whether there is a difference.
Wiki David Grabiner

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Re: Tax question - California depreciation recapture

Post by MarkNYC » Tue Jan 14, 2020 9:45 am

grabiner wrote:
Tue Jan 14, 2020 9:07 am
MarkNYC wrote:
Tue Jan 14, 2020 12:24 am
grabiner wrote:
Tue Jan 14, 2020 12:01 am
MarkNYC wrote:
Mon Jan 13, 2020 11:06 pm
In the instructions to Form CA(540) it states: "Get FTB Pub. 1001 for more information about...basis adjustments related to property acquired prior to becoming a CA resident." In FTB Pub.1001 Supplemental Guideline to CA Adjustments, in the section on Gains and Losses, in the subsection on Gain on Sale of Principal Residence, it states "if there is difference between the amount excluded (or depreciated if recapture applies) for federal and California, complete CA Schedule D..."

Essentially, your basis is higher for CA than federal, so your CA total gain is less. You should look into it further to ensure your facts coincide with CA law, and for full and proper procedures for correct reporting.
The publication is not yet available for 2019, but here is the 2018 version

But Publication 1001 doesn't really help with this situation. It says that if you claimed different depreciation under CA and federal law, you adjust on CA Schedule D to report the correct amount. So you need to compute what the depreciation would be under CA law, and adjust accordingly.
David,
In what specific section/page of 2018 Pub 1001 do you see that instruction?
Just the section you quoted; my comment was about the lack of any other guidance. "If there is difference between the amount... depreciated if recapture applies, complete CA Schedule D." This says nothing about why there might be a difference in depreciation, so you have to look elsewhere in the CA laws, such as differences between federal and CA depreciation rules for past years, to see whether there is a difference.
If we're looking at the same section, it appears you misquoted the instructions, adding an important phrase that isn't there. You said the instructions say "...if you claimed different depreciation under CA and federal law, you adjust on CA Schedule D...". The instructions don't say anything about depreciating using different law for CA and federal. The instructions do say that CA conforms to federal law regarding the principal residence exclusion, and simply states that if the excluded or depreciated amounts are different for CA and federal, the difference should be reported on the specified tax form, which then results in an adjustment to the gain on the sale. The specific reason for the difference is not required by the instructions or the CA tax forms.

That said, instructions are not authoritative law, so the OP should research it further.
Last edited by MarkNYC on Tue Jan 14, 2020 6:18 pm, edited 2 times in total.

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fyre4ce
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Re: Tax question - California depreciation recapture

Post by fyre4ce » Tue Jan 14, 2020 10:42 am

I agree it’s ambiguous, but it certainly opens the door for there being a difference. Besides a California CPA, I wouldn’t know where to go for further guidance.

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