Decpreciation Recapture and Capital Gains on a primary converted

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Decpreciation Recapture and Capital Gains on a primary converted

Jimmie Dickey
Auburn, AL · Member since 2016 · 19 posts · 1 vote

First, thank you all for taking the time to answer the questions that come up on here. I know some are repetitive. We may be relocating soon and I don't want to be in this rental market from a couple hundred miles away. I'm trying to plan whether I'd be better off selling a rental property now, or waiting a little longer as far as tax calculations go....We've got a lease, but we've also got provisions to get out should we decide to sell. And I know I need an accountant, but I'm going to wait a month or so until tax season dies down...using round numbers for the sake of simplicity, but these are very, very close. Very minimal improvements. 

May 2008: Purchased as primary residence for $155,000 (116,000 house, 39,000 land)

July 1, 2014: Went into service as rental, depreciation begins

Depreciation taken so far: $6,773 and growing by 315.08/month

Market Value today: 160,000 (120,000 house, 40,000 land)

I'm calculating it in a way that makes no logical sense to me. 

So...what would you calculate my basis as given the above info? 

What would be my actual gain?

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Wayne Brooks
Real Estate Professional · West Palm Beach, FL · Member since 2012 · 23k+ posts · 13k+ votes
10y

@Joe Splitrock is wrong in his calculation. 

@Jimmie Dickey,  Right now you'd just owe taxes on the depreciation recapture.    As long as you sell prior to it being a rental for 3 years, you get the section 121 primary residence exclusion.  There is little to no gain otherwise, you'd likely sell at a loss, after sales costs.

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  • Joe SplitrockPro Member
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    Rental Property Investor · Sioux Falls, SD · Member since 2015 · 9k+ posts · 18k+ votes
    10y

    Your basis was determined at the time it was converted to a rental. Based on $315.08 per month, you established a building value of $103,976.40 as the value on July 1, 2014. I say that because it is equal to 27.5 X 12 X $315.08 (monthly depreciation). Take the value minus $6773 and it is $97,203.40 so if you sell for $160,000 then your gain is $62,796.

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  • Jimmie Dickey
    OP
    Auburn, AL · Member since 2016 · 19 posts · 1 vote
    10y

    Thats part of my problem-There is obviously a lot of bad information out there. I read one today from what I considered a reputable source that the value at the time it was put into service was only used if the property was sold at a loss. 

    Also...Would my basis not be that 97,203.40 PLUS the value of the land? 

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  • Joe SplitrockPro Member
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    Rental Property Investor · Sioux Falls, SD · Member since 2015 · 9k+ posts · 18k+ votes
    10y

    I forgot to add that since you lived in the property at least 2 out of the previous 5 years you should avoid capital gains tax @Jimmie Dickey. That would be a good reason to sell now or in the next year.

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  • Joe SplitrockPro Member
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    Rental Property Investor · Sioux Falls, SD · Member since 2015 · 9k+ posts · 18k+ votes
    10y
    Originally posted by @Jimmie Dickey:

    Thats part of my problem-There is obviously a lot of bad information out there. I read one today from what I considered a reputable source that the value at the time it was put into service was only used if the property was sold at a loss. 

    Also...Would my basis not be that 97,203.40 PLUS the value of the land? 

    Land is not part of depreciation. You pick the basis using one of a couple different methods. I would have personally just used by purchase value in your case but your CPA must have had some other idea. Anyway it is not a concern since you lived in it recently.

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  • Jimmie Dickey
    OP
    Auburn, AL · Member since 2016 · 19 posts · 1 vote
    10y

    i appreciate the insight. This is the part that isnt logical to me....i paid 155, had 5k in appreciation, took 6700 in depreciation, but have to pay taxes on a 62,000 gain??

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  • Wayne Brooks
    Real Estate Professional · West Palm Beach, FL · Member since 2012 · 23k+ posts · 13k+ votes
    10y

    @Joe Splitrock is wrong in his calculation. 

    @Jimmie Dickey,  Right now you'd just owe taxes on the depreciation recapture.    As long as you sell prior to it being a rental for 3 years, you get the section 121 primary residence exclusion.  There is little to no gain otherwise, you'd likely sell at a loss, after sales costs.

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  • Jimmie Dickey
    OP
    Auburn, AL · Member since 2016 · 19 posts · 1 vote
    10y

    Thanks for the info to both of you guys. 

    We are in the boat that we may be selling our primary residence within the same time frame and would more than likely want to use the capital gains exclusion on that, as we have a more substantial, actual gain. 

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  • Dave FosterBusiness Member
    Qualified Intermediary for 1031 Exchanges · St. Petersburg, FL · Member since 2013 · 9k+ posts · 9k+ votes
    10y

    @Jimmie Dickey, Your basis in that property is the lower of your basis when you bought it or fair market when you converted it.  According @Joe Splitrock, calcs your depreciable basis was about 104K when you converted it.  Add the land to that and you get a basis on putting it into service of around 144K.  Add improvements to the basis and subtract depreciation  That is your adjusted basis. and then subtract closing costs on the sale of 160, calculate the difference between basis and net sale and that is what your gain will be. Not much.

    @Wayne Brooks is correct all of that gain will be exempted as long as you sell within three years of converting it into a rental.

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  • Steve Vaughan
    Rental Property Investor · East Wenatchee, WA · Member since 2014 · 10k+ posts · 16k+ votes
    10y

    As others smarter than me have stated, taxes for you are not a material factor in this transaction.  Even if it was a rental the whole time, you'll basically be breaking even when the dust settles.  Just be sure to enter your depreciation recapture correctly @Jimmie Dickey.  Online tax software can help with simpler things like this.

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  • Jimmie Dickey
    OP
    Auburn, AL · Member since 2016 · 19 posts · 1 vote
    10y

    "Breaking even" would be outstanding with me. Our initial reason for turning this one into a rental was that we were ready to build our next home, but the market totally sucked in that area 2-3 years ago. There was no way I was going to write a check just to move out of that house (like a few of my former neighbors did). The neighborhood is full of nice 'starter' homes and a lot of folks were so eager to move up that they made what I consider to be bad decisions. The market recovered stronger and quicker than I thought it would, so now instead of writing a check back then, we should be able to cash out 15K-ish in equity.  

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