My sister purchased some property in Florida at the peak in 2005. It's now worth about two thirds of what she paid for it. If she sells it at a loss, she can't deduct the loss because it was for personal use.
But suppose she rents for a while. When she depreciates the property, can she depreciate it from her cost basis or from its current value? How long must she rent it before it becomes "income" property that is deductible when sold at a loss? Assuming she's owned it for four years, but sells it two years from now, how much of the "loss" can be deducted (or used to offset capital gains)?
She determines her depreciable cost basis as the lower of FMV on date it was placed into service as a rental, or adjusted cost basis.
Be sure she allocates between land which is not depreciable and the building, which is depreciable, Straight Line, HY, 27.5 years.
I very much recommend anyone placing rental property into service or disposing of rental property seek professional tax assistance.
While there is no specified term of rental use that changes personal use property into rental property, many tax professionals seem to accept 24 months of rental use as a practical dividing line.
The gain/loss on sale of house will be based upon the depreciable basis, which is the lower of cost or FMV. So if she purchased for 1M, and it was worth 600k when she started renting it, and she sells it for 750k 3 years later, she has a gain of 150k plus the recaptured depreciation (about 600k/27.5!.81k per year, or 65.45k over 3 years), so we're looking at 25% of 215.45k or 53.86k in tax. That's federal tax only on the sale of business property, though the rate could be lower than 25% in some cases. There's state tax too. Florida has no personal income state tax, but if your sister lives in CA, CA will want 9.55% of this 215.45k.
How much rental profit could she make in 3 years? From what I'm seeing in the Bay Area, if one has a mortgage outstanding on 65% of the original purchase price and the house was purchased a few years ago during the boom, then with expenses excluding depreciation -- mortgage interest, property tax, condo fees, professional management fees -- the rental is a net loss because the rent does not cover the expenses. On the other hand if one has no mortgage there will likely be a gain, but after depreciation there could still be a loss. Suppose the rent is $4000 a month. Suppose no mortgage, property tax $600 per month, condo fees $400 per month, management fees 6% of $4000 or $250. Net profit before depreciation is $2750. Depreciation is
600k/27.5!.81k per year, or 1.8k per month, so net profit is $950 per month. Assuming 1/3 of that is used to pay federal tax, we have to pay about $315 per month in federal taxes. Cash flow is $2750 per month, minus the $315 in taxes, or $2435 net per month, which is a little less than 90k over 3 years. About 60% of this 90k will be used to pay the 25% of 215.45k tax noted above, which is tax on the sale of business property.
Of course, rents will increase over the 3 year period that you're renting it, but in our recession the increase will be slight or not at all. And it's doubtful that the house would appreciate 25% in 3 years (from 600k to 750k). So what I'm saying is that if you start renting now and hold it for only 3 years, you'll likely lose even more through the payment of taxes.
Is this correct? At first blush it seems so wrong. At second blush, it seems it might be right.
In either event, if you found yourself in this situation, what could you do to reduce your tax exposure on a property you have a loss on? Convert back to your personal residence? Anything else?
I would have worded it differently, but yes, it's right. When property has been converted from personal use to rental the starting point for depreciation is the lesser of adjusted basis or FMV at the time of conversion. That makes it also the starting point for determining the gain/loss upon ultimate sale of the property.
When our story began it was her personal residence and she was trying to figure out a way to make tax use of a loss. If we're still at that point, there is no tax exposure. If she does convert it to a rental there will always be a recapture of depreciation when the property is sold, even if she converts it back to a personal residence. The way around it is to die without ever selling the property, in which case the heirs get it with a basis equal to FMV and all that other stuff goes to her grave with her.
Sure. But the issue is what does "gain" mean in this context? If she originally purchased it for $1 million, converted it to rental when it's worth $600,000 and then sells it when it goes back up to $750,000, she has to recapture depreciation, of course. But is there an additional $150,000 taxable income?
Pub 551 addresses this exact issue. I seem to recall having cut and pasted these paragraphs here before in some other long-forgotten thread, it's a topic that comes up every so often, I guess.
It's one of those counter-intuitive situations where your basis depends on whether you are figuring gain or loss. In some corners of the tax law, it is possible to dispose of property and have neither a gain nor a loss (and I don't mean just zero). I mean when you use the basis for purposes of figuring a gain, it yields a loss; when you use the basis for purposes of figuring a loss, it yields a gain.
From Pub 551:
"Sale of property. If you later sell or dispose of property changed to business or rental use, the basis of the property you use will depend on whether you are figuring gain or loss.
"Gain. The basis for figuring a gain is your adjusted basis when you sell the property. [example snipped]
"Loss. Figure the basis for a loss starting with the smaller of your adjusted basis or the FMV of the property at the time of the change to business or rental use. Then adjust this amount for the period after the change in the property's use, as discussed earlier under Adjusted Basis, to arrive at a basis for loss. [example snipped]"
Also I don't remember if it was mentioned earlier, but if the rental has unused passive loss carryovers, they don't get used when converting back to personal use, but rather when the property is finally disposed of. If all the gain can be excluded due to Sec. 121 (less likely now under new rules regarding periods of qualifying use), then the unused passive loss disappears.
Am still confused. How do we know whether we are figuring basis for gain or for loss (in order to know which rules to apply)? In the example of purchasing a house for 1M, converting it to rental when FMV is 600k, and selling it 3 years later for 750k, with depreciation of
On Nov 1, 1:42 pm, " snipped-for-privacy@yahoo.com" wrote: Bole
basis is $1 million; if it is sold for less than $600,000 the basis is $600,000; if it is sold for between $600,000 and $1 million, the basis is the sales price.
You don't, necessarily. Especially if you can't easily do depreciation and land/building allocation calculations in your head.
In the
Do it both ways. Use the basis for gain and see what you get, then use the basis for loss and see what you get. Then you'll know which rules apply!
In this case, you don't get a loss using the loss basis, and you don't get a gain using the gain basis, so you have neither a gain nor a loss (if I did that correctly in my head...)
Still not sure from other comments in this thread regarding taxable unrecaptured Sec. 1250 gain, though...
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