Rental - Cost more than FMV

[geekgirldany]

Client converted personal residence in 2010 to rental. Cost ($170,000) was more than FMV (120,000). So I used FMV for depreciation.

They are going to sell it this year (2015) and is wanting taxes estimated.

It may sell between $125,000 to $140,000.... with the later being the high side and wishful.

Depreciation is $20,000 which leaves Adjusted Basis of $100,000. So say selling at $125,000, the gain would be $25,000. Sell at $140,000, gain $40,000.

My question is what about their original cost of $170,000? Are they allowed any type of loss for it?


I read Pub 551, and it seems to suggest that if you have a Gain you use YOUR adjusted basis, suggesting it would be $170,000 - 20,000 depreciation = $150,000.
If so it comes out the same???

Leaving as is, they owe tax on $25,000, is this correct?

Would greatly appreciate any help.

[Koss]

Basis

What do you mean by, "If so it comes out the same?"

If the sell the property for $140K and you use the basis that you used for depreciation when they began renting it, minus the depreciation, then they will have a gain; but if you use the original basis, minus the depreciation, then they will have a loss.

And therein lies the conundrum. Publication 551 says that when figuring a gain, you use your adjusted basis, but when figuring a loss, you use the smaller of your adjusted basis or the FMV at the time of the change to rental use.

This seems like circular reasoning. It appears to mean that in order to determine the basis, you first have to determine whether you have a gain or a loss. But how can you determine whether you have a gain or a loss without first knowing the basis??

In some cases, it may not make a difference. But on the fact pattern provided here...

The basis used to figure a loss actually produces a gain, and the basis used to figure a gain actually produces a loss!

I can't believe this issue has never been addressed before.

But I don't have an answer. Yet.

BMK

[mactoolsix]

Spreadsheet attached

See the attached worksheet - make your entries in the green cells - no gain, no loss

Hope that helps,

Mike

[Koss]

Possible Answer

I'm still trying to get my head around this, but this article, published on the website of a CPA firm in northern Ohio, appears to offer an interpretation of the rules that avoids the circular reasoning.

Their example appears to match the fact pattern of the original post exactly. The selling price of the property is more than the original cost basis (adjusted for depreciation), but less than the FMV basis (adjusted for depreciation) that was used at the time of conversion.

Their conclusion is that in this situation, there is neither a gain nor a loss.

http://blog.skodaminotti.com/blog/tax-consequence-of-converting-your-primary-residence-to-rental-property/

Disclaimer: I know nothing about this firm or the author of this article. Just because it's on the internet doesn't mean it's true.

BMK

[Koss]

Spreadsheet

See the attached worksheet - make your entries in the green cells - no gain, no loss

Hope that helps,

Mike

mactoolsix beat me to it, with the same conclusion. We were typing at the same time.

But how do you report the sale on Form 4797?? Enter a basis that is equal to the sales price?

Presumably it has to be reported, because the seller will get Form 1099-S.

BMK

[geekgirldany]

Thank you both so much. Mike for the spreadsheet. That really does clear up one part of it..... and Koss posted the website link.

But that also leads me to the same questions.... how to report the sale on form 4797?

[Koss]

Reporting the Sale

You certainly want to enter the sales price in Column D, so that it matches what is reported on Form 1099-S.

In Column E, you would either enter the original basis or the FMV at the time of conversion, adjusted for depreciation.

Then you enter an appropriate adjustment in Column G, so that Column H is zero.

In Column F, you would use code O (the letter O, not the number zero).

As to which basis you enter in Column E...

What difference does it make?

Seriously. The IRS has no idea what the taxpayer's basis in the property is.

Assuming that the interpretation provided by Mike and the firm in Cleveland is accurate, then it doesn't matter which basis you use, as long as you enter the appropriate adjustment. If the net result, i.e., a zero in Column H, is correct, then the tax return will survive an audit.

BMK

[Koss]

Re: Reporting the Sale

My references to columns were to Form 8949, not Form 4797...

I always get confused when it comes to the sale of rental property.

BMK

[geekgirldany]

Yeah, the rental is reported on the second page of 4797. Trying to figure this out.

[mactoolsix]

Thank you both so much. Mike for the spreadsheet. That really does clear up one part of it..... and Koss posted the website link.

But that also leads me to the same questions.... how to report the sale on form 4797?

Sorry for the delay - got called to dinner.

You are welcome, and I agree with Koss's answer (#7) "O" column "f" make an adjustment to zero any gain or loss. Then include an explanation of your no gain / loss.

Mike

[Koss]

Form 4797

Unlike Form 8949, Part III of Form 4797 doesn't have a field for adjustments to basis.

There is a field for the gross sales price, and a field for depreciation. Those fields can be completed with the appropriate numbers.

I think you just have to back into the correct basis in order to produce a gain/loss of zero.

And, as Mike suggested, you could attach an explanation.

BMK

[geekgirldany]

So just adjust the number until it comes to zero and attach a explanation?

My client will be glad to hear this news.