Sale of Rental

[GTS1101]

I have what I think is a stupid question that I should have an answer to as an EA but I am not sure. I was hoping for some guidance from the great wisdom on this board.

Let's say for example you buy a principal residence for 90,000 and you do 10,000 of home improvements. Basis is now 100,000. Then you sell for 300,000 and you have a gain of 200,000.

If you convert that property from principal residence to a rental you have to use either your adjusted basis or the FMV whichever is lower as your basis for depreciation. So let's say in the example above you convert to a rental and at the time of conversion the FMV is 75,000. So your basis for depreciation is 75,000.

When you go to sell this rental can you add the 25,000 to the basis and use 100,000 as the basis again having a gain of 200,000 plus the depreciation? Or are you stuck with a gain of 225,000 plus the depreciation because you have to use the basis for depreciation which was 75,000 as the basis. Seems like this should be an easy answer but I am stumped for whatever reason. Maybe I am thinking about it to hard.

Another thing that seems wrong is this unrecaptured section 1250 gain that you have to pay on straight line depreciation you have taken since 5/16/1997. My client has about 30,000 in depreciation over the years so they may have to pay up to 7,500 in capital gain just for depreciation under straight line. I could understand if it was accelerated depreciation and having to recapture but for straight line deprecation it just seems wrong. I guess another way for the government to make sure they get their cut.

GTS1101

[solomon]

I have what I think is a stupid question that I should have an answer to as an EA but I am not sure. I was hoping for some guidance from the great wisdom on this board.

Let's say for example you buy a principal residence for 90,000 and you do 10,000 of home improvements. Basis is now 100,000. Then you sell for 300,000 and you have a gain of 200,000.

If you convert that property from principal residence to a rental you have to use either your adjusted basis or the FMV whichever is lower as your basis for depreciation. So let's say in the example above you convert to a rental and at the time of conversion the FMV is 75,000. So your basis for depreciation is 75,000.

When you go to sell this rental can you add the 25,000 to the basis and use 100,000 as the basis again having a gain of 200,000 plus the depreciation? Or are you stuck with a gain of 225,000 plus the depreciation because you have to use the basis for depreciation which was 75,000 as the basis. Seems like this should be an easy answer but I am stumped for whatever reason. Maybe I am thinking about it to hard.

Another thing that seems wrong is this unrecaptured section 1250 gain that you have to pay on straight line depreciation you have taken since 5/16/1997. My client has about 30,000 in depreciation over the years so they may have to pay up to 7,500 in capital gain just for depreciation under straight line. I could understand if it was accelerated depreciation and having to recapture but for straight line deprecation it just seems wrong. I guess another way for the government to make sure they get their cut.

GTS1101

Using these numbers the gain would be 255,000 of which 30,000 would be taxed up to a maximum of 25% and 225,000 taxed at the capital gain rate.

Regarding the unrecaptured 1250 gain seems wrong, the maximum rate at 25% for a higher income taxpayer is a good deal. Were it actually depreciation recapture, then it would be taxed at the ordinary income rate - which for high income could be at least 35% and soon probably more.

Sold at a gain so basis is 100K. Gain not 255K. Gain 170K.

[Kram BergGold]

basis

your basis for figuring gain is 200k. your basis for figuring loss is 175k. although the following will not apply in your scenario, as there is clearly a gain, i will tell you if when you figure for gain you have a loss and when you figure for loss you have a gain then it is a push and you have zero gain and zero loss. i have seen this once.

[GTS1101]

Basis?

Now you both have really confused me. Why are you changing the basis whether a gain or a loss. This is not a gift basis. What are you trying to communicate to me.

Solomon you said the gain is now 170,000. How did you calculate that. If you use the basis as 100,000 - 30,000 depreciation = 70,000 adjusted basis. Sold for 300,000. Gain is 230,000. instead of 255,000?

My main question again was if you have to use the FMV which is lower than the adjusted basis when converting to rental is that your basis when you go to sell or can you add in the improvements to that basis?

So you buy home for 90,000 you do 10,000 of improvements. Total basis 100,000.
When converting to rental FMV is 75,000 so you have to use 75,000 as your basis. When you sell it is sold for 300,000. What do you use as the basis? Are you stuck with 75,000 or can you add the 25,000 improvements to it when you go to sell?

GTS1101

[WhiteOleander]

I would use the purchase + improvement basis to figure gain or loss on the sale. The fact that a different basis had to be used for depreciation does not mean the t/p cannot use their actual investment for figuring gain/loss. You would of course adjust the basis by the depr. allowed or allowable.

[solomon]

So you buy home for 90,000 you do 10,000 of improvements. Total basis 100,000.
When converting to rental FMV is 75,000 so you have to use 75,000 as your basis. When you sell it is sold for 300,000. What do you use as the basis? Are you stuck with 75,000 or can you add the 25,000 improvements to it when you go to sell?

GTS1101

Yes the 75K is the basis for depreciation.

§ 1.167(g)-1 Basis for depreciation.

The basis upon which the allowance for depreciation is to be computed with respect to any property shall be the adjusted basis provided in section 1011 for the purpose of determining gain on the sale or other disposition of such property. In the case of property which has not been used in the trade or business or held for the production of income and which is thereafter converted to such use, the fair market value on the date of such conversion, if less than the adjusted basis of the property at that time, is the basis for computing depreciation.

When selling at a gain the adjusted basis is used which would include any improvements. When selling at a loss the lesser of the adjusted basis at conversion plus improvements or the FMV at conversion plus improvements is used.

Sale Price -------------------- ----------- 300,000
Basis 100K plus 25K improvement -- 125,000
Depreciation ------------------------------ 30,000

Gain --------------------------------------- 145,000

Ostensibly you are not differentiating between the basis for depreciation and the basis for sale and I included the 25K improvement which I did not do in prior post.

[appelman]

See p. 10 of Pub. 551

See p. 10 of Pub. 551. The examples under "Property Changed to Business or Rental Use" should answer your questions. You may, in fact, have to use a different basis depending on whether you have a gain or loss.