sale of duplex - rental and personal use

[mblatour]

Hi!

Okay, I'm looking for a little guidance with a scenario I've never dealt with before. I am hoping for someone who is very familiar with this type of situation (maybe I'll get lucky, lol).

I have a client (John) who was married last year, but separated. In May '09 John's divorce became final. This happened on the same day that his fiance (Jane)'s divorce became final as well, which then became John and Jane's wedding day to one another, later that afternoon.

Jane had been living in one side of a duplex house that she and her ex husband (Tom)had purchased back in 1996 together for $31,750. One side has always been rented out, while Tom and Jane lived in the other side. Tom moved out a while back, and Jane remained in the rental until April '09, when she moved in with John. Jane sold the rental in Oct. '09 for $99,500. By the way, she was awarded the duplex in the divorce.

How do I handle the disposition of the rental? Depreciation recapture? Gain/Loss? There was about $10,000 in settlement charges related to the sale, and of course there were all sorts of items on the depreciation report (such as electrical update, windows, appliances, etc. over the years).

I've done about 2 hours of reading this evening but I am so backed up on returns now because I took a full time job in addition to my tax biz and two young sons. I could really use some help from someone familiar with this topic. I've got things started on the 4797 but I am not sure if I am doing it right. I use ProSeries if that helps you any.

Thanks so much!!

Becky (a.k.a. - overworked )

[Lion]

Two Sales

Break it down into two sales. She sold her personal residence and the land, if the units were the same, 50%. She sold the rental unit and land, another 50% or whatever percent. Apply half (or the appropriate percentage) of the sales proceeds and half the selling costs to the rental sale. You should have the cost basis and various components in your program already, maybe have to add back land if you weren't carrying a line for non-depreciable land.

[mblatour]

a little more direction please....

I am re-visting this return. I got it as far as I could get it without finishing up the sale of the duplex info.

I know that the "gain" on the sale of the personal residence side of the duplex will have no tax consequence because of the $250,000 exclusion. But as far as for the gain on the business/rental side of the duplex, I'm not sure I am figuring things out correctly.

She initially paid $31,750 for the duplex in '96. Since then, there has been depreciation for 1/2 of the cost of the following items:

-the rental itself
-furniture and fixtures
-water heater
-electrical update
-lawn mower
-gas range
-water pump
-windows
-window treatments

which all totaled up to $31,299 in basis for depreciation (so far $17,662 has been taken). The expenses to sell the duplex were $10,500- which only $5,250 would be allocated to the business part of it. The sales price of the duplex was $99,500.

So would I take half of the sale proceeds

99,500 x 50% = $49,750

add back prior depreciation of:

$17,662 .................................49,750 + 17,662 = $67,412

And then take the cost/basis of:

$36,549..................................31,299 + 5,250 = $36,549

Total gain is now: $67,412 - $36,549 = $30,863. Can this be right?!!

If this is true, my client will owe the Fed and State over $9,000 in tax. Please help. I don't want to be wrong on this.

Thanks,
Becky

[Gretel]

Becky,

I come up with the same figure for the gain. What I am missing in your calculation is a figure for the land. Was the land included in depreciation or did she actually pay more originally?

Then only the depreciation is taxable up to 25% depending on income. The remaining gain might escape tax totally (0% in 15% bracket), also depending on income.

[mblatour]

clarify please....

"Then only the depreciation is taxable up to 25% depending on income. The remaining gain might escape tax totally (0% in 15% bracket), also depending on income."


What do you mean only the depreciation is taxable? BTW this couple is in the 25% tax bracket. Oh, and the land is not separated, it's on a small lot that was figured in as part of the original cost of the duplex.

Thank you so much for your reply.

Becky

[Gretel]

I am not good at explaining complex issues. I also don't know all the inns and outs on this subject either. I suggest you look at pg. 6-12 TTB.

All I can say is that the tax in your scenario is divided between depreciation recapture and capital gains. Clients being in the 25% tax bracket will make all the gain taxable at two different rates (25% & 15%).

The software will do this for you and you will see the breakdown on Sch. D. part III were the figures from form 4797 will flow to. I once spend quite some time looking over these transactions just to understand what and why it was done. Sorry, that I cannot explain this to anyone else.

[dyne]

The total gain of $30,863 is correct. The over $9,000 fed and state tax sounds high!
On a test return with low income the tax was less than $3,000.

[Gretel]

Actually knowing the tax bracket I think the total tax should be:

$6,396 - 25% of 17,662 plus 15% of 13,201

[mblatour]

Yep, still working on this....

I had this return on hold while waiting for client to provide additional information. I went over what I've done so far with her and when I told her about the amount she originally paid for the rental being $31,750, she responded "What? I paid $65,000 for the rental". Her ex has all of the original paperwork, but she did request from the lender to be sent copies; waiting on those now. She did send me a copy of her credit report with a page on it that show the original loan amount.

So now what? This rental has been depreciated at a totally different amount for the past 13 years. I have to somehow calculate her capital gain, but I'm going off of numbers that were calculated wrong all those years. I know depreciation goes by what was allowed; not what was actually taken which means I will have to calculate what depreciation she COULD have taken on the rental all of that time. And of course her cost/basis is going to increase as well. What a pain!

Anyone have any thoughts as to what I should watch out for here?

Thanks,
Becky

[Lion]

Land?

Only the building is on her depreciation schedule, but she would've purchased both land and building. Or, did she split the income and expenses and depreciate with her spouse, so that she's reporting only half? Does she have any notes, her own or her preparer's, in her folder for the year it was place in service? Or is that line the rental half and she's remember the price for the whole building including their personal residence?

[mblatour]

hmmmm

Lion,

I've asked myself a lot of those same questions. When the loan was taken out, it did not break apart values for the house and the land separately. How does one go about determining the value of a lot? The house had been there for many decades. It's in a low value side of town and the lot is barely bigger than the house itself. There is no way that the old preparer would have figured that the lot was more valuable than the house.

Her previous preparer took the amount of $31,750 as the cost of the duplex. It is listed at 50% business use. So then the basis for depreciation is listed as $15,875. If they paid $65,000 for it, at 50% business use they'd have a basis of $32,500. My client and her ex never filed as MFS, so therefore the basis and expenses were not split. She does not have the tax prep folder from the year it was placed in service. That was back in 1996 and she doesn't think her ex kept it either. Their not exactly on speaking terms right now.

I'm really tired of this return and I don't know how to clean it up. Ugh.

[Lion]

Land

You could check the ratio of land to building on the property tax card at the town clerk's office for the year purchased. I'll bet the land value is the other piece of the purchase price that's missing from your depreciation schedule. Unless the prior preparer listed a line for land - non-depreciable on the schedule, that could be it.

[mblatour]

lion,

I just looked up on our County Assessors website for that property and as of 04/01/10 it lists the following:

Land: $11,800
Building: $83,600
Total Value: $95,400.

I haven't found how to go back and look at 1996, but if it's only valued at $11,800 now, there really is no way I can believe that it was valued at 3 times that amount 14 years ago.

What do you think?

[Lion]

Regional

I'm sure it's a regional thing, but around here the land is worth a lot more than an old building on the land. How much was the building insured for at first? That would be the building only and not land. Did their bank do an appraisal when they purchased the property? That would break out land and building. Send your client to the assessor's office to look up the relative values when they purchased. Or, when they placed it in service, if different dates -- lower of cost or FMV on date placed in service.

[gkaiseril]

When I have a newly purchased rental, I set up the depreciation for the entire building and land. Assign a business percentage and compute the value of th business portion. Then one needs to assign a value to land and other non-depreciable portions which is subtracted from the business basis to obtain the depreciable basis. This also documents the valuation of the land and building for later transactions. Then I use the depreciable basis for computing the depreciation of the building. And upon sale, I use the value assigned to the land as the cost basis of the land. and the computed depreciable basis as the cost of the building and apply the allowed or allowable depreciation. I also have details as to any other assets add to the rental and columns for the details of how the depreciable amount was determined at the time the asset was placed in service.