Need help on capital gains from real estate sale

[kaneohe]

The house is already rented for 35 years, if I'm not mistaking. You can depreciate the first 27.5 years, therefore it might not be possible to recapture. Depreciation is gone.


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Suppose the house had been rented for 35 yrs. I understand you can't depreciate any more since "book value" of property is now 0. I don't understand the no recapture if you sell.....is that true?

 

[Souschef]

I think there is some confusing and conflicting items here. Example: you itemize and deduct your state tax payment. You get a refund, and have to report the refund as income, because you really did not pay all that tax.
If the OP never deducted depreciation, there is no recapture. I had a rental that I depreciated, so when I sold it I had to recapture the depreciation, because it changed the basis of my rental.

 

[pb4uski]

No, the rules specifically require that you recapture even if your did not claim depreciation. Stupid I agree, but nonetheless that is the way it is.

 

[pb4uski]

Suppose the house had been rented for 35 yrs. I understand you can't depreciate any more since "book value" of property is now 0. I don't understand the no recapture if you sell.....is that true?

No, if you sold a fully depreciated asset then your basis would be zero.... the entire net sales proceeds would be gain and the amount of the gain equal to the past depreciation would be ordinary and any excess would be capital.

 

[kaneohe]

No, if you sold a fully depreciated asset then your basis would be zero.... the entire net sales proceeds would be gain and the amount of the gain equal to the past depreciation would be ordinary and any excess would be capital.

pb4uski.........thanks, that makes more sense.

 

[Texas Proud]

I think there is some confusing and conflicting items here. Example: you itemize and deduct your state tax payment. You get a refund, and have to report the refund as income, because you really did not pay all that tax.
If the OP never deducted depreciation, there is no recapture. I had a rental that I depreciated, so when I sold it I had to recapture the depreciation, because it changed the basis of my rental.

The words the IRS use is depreciation allowed or allowable....

IOW, you have to take into account the actual depreciation you took (if you took more than you were supposed to) or that you should have taken (even if you took zero)....


No free lunch here....

 

[Texas Proud]

I am going to throw out a separate thought...

So, to the OP....

Did your friend and you agree that she would own the property after the 35 years of paying the mortgage?

Or was that just in your head and you could change your mind?



It sounds like the latter since you kicked her out. But, if it is the former, then you could say you sold the property under contract... my dad used to do this back in the 60s and 70s... kinda like you hold the mortgage and they keep paying and when paid off you transfer the title... you would not take depreciation on the property if so... However, you should have been recognizing interest income each year.... so again, a different tax problem...

 

[pb4uski]

TP, it seems like the OP can get in enough tax trouble on his own.... he doesn't need any help from you.

Seriously though, that sounds like a high risk strategy. With no documentation what the OP and his tenant did for past tax returns would be more indicative of what the deal was.

 

[RunningBum]

I am going to throw out a separate thought...

So, to the OP....

Did your friend and you agree that she would own the property after the 35 years of paying the mortgage?

Or was that just in your head and you could change your mind?



It sounds like the latter since you kicked her out. But, if it is the former, then you could say you sold the property under contract... my dad used to do this back in the 60s and 70s... kinda like you hold the mortgage and they keep paying and when paid off you transfer the title... you would not take depreciation on the property if so... However, you should have been recognizing interest income each year.... so again, a different tax problem...

I can't see any way in which that's a better solution.

The transaction didn't actually take place at any point, so I don't see how the IRS would accept that. Post dating documents would be fraud.

If you could make it happen, then what? The friend now owns the house, and the OP owns a mortgage which she is no longer paying? So now he has to go through a legal repossession? What if she decides to keep it and keep paying or refinances and buys him off? How much does she owe him, since there was no agreement on a purchase price?

 

[Letj]

I think there is some confusing and conflicting items here. Example: you itemize and deduct your state tax payment. You get a refund, and have to report the refund as income, because you really did not pay all that tax.
If the OP never deducted depreciation, there is no recapture. I had a rental that I depreciated, so when I sold it I had to recapture the depreciation, because it changed the basis of my rental.

The IRS rules requires the OP to recapture whether you take the depreciation or not.


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[Cobra9777]

...Your best bet is to hire a CPA. They'll likely recommend amending any past returns that are still open to being amended to include Schedule E and depreciation of the property so you get some benefit and then the profit from the sale will be bifurcated between depreciation recapture which will be taxed as ordinary income and capital gains which will be taxed at capital gains rates.

Are you sure the bolded part is correct? Several people have mentioned ordinary income rates.

For rental real estate, it was my understanding that capital gains attributable to straight-line depreciation are not recaptured at ordinary income rates. Rather, they are taxed at a special maximum capital gain rate of 25%, or at your marginal rate if lower than 25%.

 

[ReadyAimFired]

Ok, saw the CPA got the answers I need and they will be filing my taxes this year to handle the situation. Provided all of the documentation and the CPA will be handling it. I will be paying the depreciation. I explained everything surrounding the house, only owned 13 years and not 35, and the CPA gave me all of the information I need.

Once the CPA had all of the information surrounding the house and the person living in it she gave me some great advise. Thanks to all that took the time to get involved with my question. I told her that I would pay whatever monies I needed to pay to not have the IRS breathing down my back. I don't want to be charged with fraud, if I made a mistake that I would take full accountability.

 

[pb4uski]

Are you sure the bolded part is correct? Several people have mentioned ordinary income rates.

For rental real estate, it was my understanding that capital gains attributable to straight-line depreciation are not recaptured at ordinary income rates. Rather, they are taxed at a special maximum capital gain rate of 25%, or at your marginal rate if lower than 25%.

Pretty sure. Publication 544 says:

Depreciation Recapture

If you dispose of depreciable or amortizable property at a gain, you may have to treat all or part of the gain (even if otherwise nontaxable) as ordinary income.

It might well be that special tax rates apply but it seems to be ordinary income.

Edited to add: It looks like is is subject to special rates:

While this section is correct for Section 1245 property (in the U.S.A), it is not correct for Section 1250 property. For Section 1250 assets (real estate), Recaptured Depreciation is defined as "Additional Depreciation" in IRS Publication 544 (see column 3 on page 30 of the 2010 version of this publication). Additional Depreciation is the portion of Accumulated Depreciation in excess of straight line. It is taxed at ordinary income tax rates, which have a maximum rate of 39.6% (to the extent of any gain realized). The portion of Accumulated Depreciation which corresponds to straight line depreciation is called "Unrecaptured Section 1250 Gain" (though sometimes informally called "Unrecaptured Depreciation", and it is taxed at a maximum rate of 25% (also to the extent of any gain realized). The remainder of any gain realized is considered long-term capital gain, provided the property was held over a year. .....

https://en.wikipedia.org/wiki/Depreciation_recapture

 

[Cobra9777]

Thanks. The Wikipedia quote is consistent with my understanding. I had been advised by a tax professional that selling my rentals would be 100% capital gain, not ordinary income. But the portion resulting from accumulated depreciation would be taxed at a special CG rate of 25% (assuming 25% bracket or higher; lower for other brackets). The rest would be taxed at ordinary CG rates.

Apparently, this is not considered "depreciation recapture" at all, but rather a special kind of capital gain called "unrecaptured Section 1250 gain." Ordinary income only applies to true depreciation recapture. For rental real estate (section 1250) this is pretty rare as it would only affect that portion of the gain resulting from depreciation taken in excess of straight-line rates, which have been in effect since the 1980s.

Here's a recent article from Marketwatch which describes all the various capital gain rates, and is considerably easier to read than IRS publication 544. Here's a quote describing the 25% rate for real estate:

Investment real estate
The 25% rate

Who’s Eligible: Property owners and real-estate investment trust (REIT) investors in the 25% income-tax bracket or higher who hold property for more than one year.

Investment real estate gains are tricky since they can be taxed in two different ways. If you claim depreciation deductions, at least some of those gains (so-called unrecaptured Section 1250 gains) are taxed at a maximum federal rate of 25%.

For example, say you own a rental duplex and have deducted $32,000 of depreciation over the years. That depreciation reduces your basis in the property and results in a bigger taxable gain (or smaller loss) when you sell. Now you sell for a $100,000 gain. The first $32,000 (the unrecaptured Section 1250 gain) is taxed at a maximum federal rate of 25%. The remaining $68,000 of gain is taxed at the “general rule” maximum federal rate of no more than 20%.

If you own shares in a REIT, you can receive capital-gains distributions subject to the 25% maximum rate. This happens when the REIT sells a piece of depreciable property and distributes the profit to its shareholders.

To the extent an unrecaptured Section 1250 gain falls into the 10% or 15% bracket, it gets taxed at that rate.

 

[outabout]

I sold a rental property in 2014, and had to recapture depreciation allowed or allowable.

There is a way to retroactively claim previous unclaimed depreciation by using form 3115 Change in Accounting Method, this allows you to do all previous years in one form, and you don't have to deal with amended returns which would only go back 3 years. In this form, you would select change from "impermissible (not taking depreciation) method" to "permissible method (taking appropriate depreciation)". Some CPAs don't even know about this method, so you need a good one.

I am quite certain this can be used BEFORE you sold the property, but it is possible it can be used AFTER as well as long as you owned the property in the tax year you file 3115. You need to ask your CPA

 

[Texas Proud]

TP, it seems like the OP can get in enough tax trouble on his own.... he doesn't need any help from you.

Seriously though, that sounds like a high risk strategy. With no documentation what the OP and his tenant did for past tax returns would be more indicative of what the deal was.

I can't see any way in which that's a better solution.

The transaction didn't actually take place at any point, so I don't see how the IRS would accept that. Post dating documents would be fraud.

If you could make it happen, then what? The friend now owns the house, and the OP owns a mortgage which she is no longer paying? So now he has to go through a legal repossession? What if she decides to keep it and keep paying or refinances and buys him off? How much does she owe him, since there was no agreement on a purchase price?

A verbal contract is still a contract....

As I said, it was contingent on what was agreed too.... not doing it after the fact...

My dad sold a number of houses by contract... most people stopped paying.... you do not have to repo the house as the title never changed hands... dad always owned the house...

 

[RE2Boys]

I sold a rental property in 2014, and had to recapture depreciation allowed or allowable.

There is a way to retroactively claim previous unclaimed depreciation by using form 3115 Change in Accounting Method, this allows you to do all previous years in one form, and you don't have to deal with amended returns which would only go back 3 years. In this form, you would select change from "impermissible (not taking depreciation) method" to "permissible method (taking appropriate depreciation)". Some CPAs don't even know about this method, so you need a good one.

I am quite certain this can be used BEFORE you sold the property, but it is possible it can be used AFTER as well as long as you owned the property in the tax year you file 3115. You need to ask your CPA

See Publication 946 - How to Depreciate Property - How Do You Correct Depreciation Deductions? for the hoary details and why a CPA may be useful.

 

[pb4uski]

.... My dad sold a number of houses by contract... most people stopped paying.... you do not have to repo the house as the title never changed hands... dad always owned the house...

If title never changed and your dad always owned the house then how can you say that he "sold" the house? Did any of these arrangements ultimately result in change of title? If so, how did the sale work for tax purposes?

My dad did a number of installment sales of real estate but they were a true sale where title changed and he provided seller-financing and it spread the capital gain out over a number of years. He received every payment in all cases.

 

[RunningBum]

Ok, saw the CPA got the answers I need and they will be filing my taxes this year to handle the situation. Provided all of the documentation and the CPA will be handling it. I will be paying the depreciation. I explained everything surrounding the house, only owned 13 years and not 35, and the CPA gave me all of the information I need.

Once the CPA had all of the information surrounding the house and the person living in it she gave me some great advise. Thanks to all that took the time to get involved with my question. I told her that I would pay whatever monies I needed to pay to not have the IRS breathing down my back. I don't want to be charged with fraud, if I made a mistake that I would take full accountability.

So what were the answers and advice? Since you asked for help here it only seems fair that you share the result.

 

[pb4uski]

+1

 

[Souschef]

A verbal contract is still a contract....

One of the first things I was taught in Real Estate school was that in California, at least, verbal contracts are invalid in real estate transactions.
The bottom line is that the OP is best served , as a number of people have said, is going to a CPA with Real Estate expertise..

 

[pb4uski]

One of the first things I was taught in Real Estate school was that in California, at least, verbal contracts are invalid in real estate transactions......

Yes, now that you mention it, that is my memory as well when I took real estate law in college and sat for the real estate agent exam.

 

[Texas Proud]

If title never changed and your dad always owned the house then how can you say that he "sold" the house? Did any of these arrangements ultimately result in change of title? If so, how did the sale work for tax purposes?

My dad did a number of installment sales of real estate but they were a true sale where title changed and he provided seller-financing and it spread the capital gain out over a number of years. He received every payment in all cases.

I actually do not know what he put down on his tax return for the sale.... I do know he put down the interest income....

Yes, one house did pay off fully... the guy paid for 20 years... after the last payment Dad signed over title to the buyer.... now, I wish this had not happened because it was a BIG house in the Heights that is probably worth well north of $1 mill.... maybe even $2 mill..... back in the 60s you could buy houses there for $15K to $30K... and he rented them out by the week... he was a slum lord for a few years....

 

[Texas Proud]

One of the first things I was taught in Real Estate school was that in California, at least, verbal contracts are invalid in real estate transactions.
The bottom line is that the OP is best served , as a number of people have said, is going to a CPA with Real Estate expertise..

Yes, now that you mention it, that is my memory as well when I took real estate law in college and sat for the real estate agent exam.

Just to add... my dad had written contracts, so no problem there....

But, from what I understand, a verbal contract is valid even with real estate if both agree on the terms... I could be wrong as I am not a lawyer or a RE agent....


Edit... looked it up... third link I looked at...

Oral Contracts

In most instances, oral contracts are legal. However, these agreements can be difficult, if not impossible, for a court to enforce. Without a signed, written contract, the court is asked to make a decision without evidence of the parties' agreement. Oral contracts are not illegal, because if both parties keep their "word," the transaction will work well. If the parties to an oral real estate contract keep their promises, a dispute will never reach the court.




http://homeguides.sfgate.com/real-estate-contract-writing-58144.html

 

[harley]

So what were the answers and advice? Since you asked for help here it only seems fair that you share the result.

+2. I have a sort of but not quite similar situation, and would be interested in what you learned.