long term carryover loss to offset depreciation recapture

7 Replies

- Purchased strip mall in 3/2003 in Chicago, IL for  $4,800K
- Sold it in 11/2017 for  $4,660K
- Closing costs for purchase/sale  $600K
- Capital improvements  $300K
- Total depreciation claimed over the years  $2,300K
- Has long term carryover loss  $550K


Questions:
- How much is the depreciation recapture, if any?
- How much is the capital gain, if any?
- How much is the capital loss, if any?
- How much is the ordinary taxable income, if any?
- How much carryover loss could offset depreciation recapture?
- How much carryover loss could offset capital gain?
- How much carryover loss could offset capital loss?
- How much carryover loss could offset ordinary taxable income?
- Going forward how much carryover loss would for future use?
- Basically how much is the tax liability of this sale?

Hi Lance,

Before sale,  asked CPA who has been doing taxes for this property for all these years, to crunch numbers given above. He assured that the gain from sale would be offset by carryover loss and there would be no tax consequences.  With this assurance moved forward and closed the sale.

Now after sale, while preparing  tax return, his calculations took 180 degree turn. There is no depreciation recapture, no capital gain, gain is just ordinary taxable income which does not qualify for carryover loss except $3000. Now the tax liability is about $140K.

Had I known above, would not have sold the property, would have held it as usual or sought 1031 exchange.

Before confronting him, need to have second opinion of truth of the situation - what is the correct - first calculation or second.    

In earlier discussion forgot to mention that the property was in partnership. I am 50% partner and have long term carryover loss of $500K.

I am not a CPA. After Google  search, have the impression that it is straight forward calculation with tax liability of about $11K after offset from carryover loss to 50% depreciation recapture of $1,200K.

Would appreciate your expert opinion.

Hoping and eager to hear from you.

Thanks,

Mohammed Quadeer

I'm not a CPA, but I'd recommend talking to a few locally that understand real estate. That's your best bet to get this mess cleared up. 

I'm guessing you took some special depreciation deductions or did cost segregation since that's way more depreciation than you'd get in 14 years on that property using the straight line method. Depreciation recapture is maxed at 25% on real property (it's more complicated if you pulled out personal property) So with $2.3mm depreciation recapture the tax bill would be $575K on the recapture assuming it's all real property, it'd be higher if you pulled out personal property unless you were proactive on mitigating that which it doesn't seem like. Then you have a $140K loss from the purchase price to the sale price which would mitigate some of the recapture and there wouldn't be any capital gain. Add the carryover loss to that and you should be pretty close to no tax liability, but I'm no expert on how carryover losses work you may not be able to use it here. And that doesn't even take into account the closing costs and improvements. 

These forums are great to learn, get advice and seek second opinions, but this situation is way too complex to be figured out on the forums. Talk to some more CPAs and get a second or third opinion, that's the only way you'll get this taken care of. 

@Mohammed Quadeer

There are a lot of moving pieces when calculating gain/loss on the sale of a property.

It appears that your accountant was referencing to suspended losses when he meant capital loss carryover?


It you had suspended losses(losses you couldn't take because your income was above $150,000) then you should be able to utilize those suspended losses to decrease your gain.

$140,000 does seem like a lot of money to pay to the IRS. you may want to get a second opinion.

unfortunately - it may be one of those issues that the person would have to see your return to give you a more precise answer.
Adding the partnership does add another level of complexity.

Hi Mr. Siddiqi,

Thanks for responding.

CPA never mentioned 'suspended losses'. This is the first time I am hearing.  Each year $3K was applied to taxable income and in 2017 the carryover loss is  $550K.  All moving parts - 1065 and 1040 are prepared. The problem started when CPA's opinion changed before and after sales.

The critical question is:  Could long term carryover loss offset depreciation recapture after sale of investment property at loss?

The answer is knowledge and expertise of tax code in this area.  I did Google search and found following links and looks like it is doable. 

Links:
https://www.quora.com/When-selling-rental-real-estate-does-depreciation-recapture-create-a-gain-that-can-be-offset-by-capital-loss-carryover
https://www.nycaccountingconsulting.com/can-long-term-capital-loss-carry-forward-offset-recapture-accumulated-depreciation-capital-gains-property-sale/
https://www.biggerpockets.com/forums/51/topics/182354-depreciation-recapture-and-passive-losses-when-selling-property-at-a-loss

To recap the problem, details are here in one place:

Property buy/sale  details:
- Purchased strip mall in 3/2003 in Chicago, IL for  $4,800K
- Sold it in 11/2017 for  $4,660K
- Note: sale price is lower than purchase price - sold at loss of $140K
- Closing costs for purchase/sale  $660K
- Capital improvements  $300K
- Total depreciation claimed over the years  $2,300K
- Property is in partnership
- This partner has 50% ownership and has long term carryover loss of $550K

Questions:
- How much is the depreciation recapture, if any?
- How much is the capital gain, if any?
- How much is the capital loss, if any?
- How much is the ordinary taxable income, if any?
- How much carryover loss could offset depreciation recapture for this partner?
- How much carryover loss could offset capital gain for this partner?
- How much carryover loss could offset capital loss for this partner?
- How much carryover loss could offset ordinary taxable income for this partner?
- Going forward how much carryover loss would for future use for this partner?
- Basically how much is the tax liability of this sale for this partner?

Background:
- Before sale, asked CPA who has been doing taxes for this property for all these years, to crunch numbers given above.
  He assured that the gain from sale would be offset by carryover loss and there would be no tax consequences.
  With this assurance moved forward and closed the sale.
- Now after sale, while preparing  tax return, his calculations took 180 degree turn.
  Claims there is no depreciation recapture, no capital gain, gain is just ordinary taxable income which does not
  qualify for carryover loss except $3000. Now the tax liability is around $140K.
- Had I known above, would not have sold the property, would have held it as usual or sought 1031 exchange.
- Before confronting him, need to have second opinion of truth of the situation -
  what is the correct? - first calculation or second. 

My understanding:
- I am not a CPA. After Google  search, have the impression that it is straight forward calculation with tax liability
  of about $12.5K after offset from carryover loss to 50% depreciation recapture of $1,200K
- After reading below links here is my 2 cents:

  A) At partnership level - Form 1065 -> Form 4797 / Part III / section 1245 property
  Gross sale          = $4,660K ===> line 20
  Cost/Basis          = $5,760K ===> line 21  ==> 4,800(PP) + 660(closing) + 300(improvement)
  Depreciation     = $2,300K ===> line 22
  Adjusted/Book  = $3,460K ===> line 23  ==> 5,760K(basis) - 2,300K(depreciation)
  Total Gain          = $1,200K ===> line 24  ==> 4,660K(gross sale) - 3,460K(Adjusted/Book)
  Dep. Allowed     = $2,300K ===> line 25a
  Dep. Recapture = $1,200K ===> line 25b ==> smaller of line 24 or 25a

  Note: from above calculations it seems:
  - there is depreciation recapture of $1,200K for partnership since gain is lower than depreciation
  - there is no capital gain for partnership since gain is not higher than depreciation 
  - there is no capital loss since total gain is not negative
 
  Critical Questions:
  - this gain of $1,200k is depreciation recapture or ordinary taxable income?
  - Is there any impact on classifying this gain since the property was sold on gross loss of $140K
  ( $4,660K(sp) - $4,800K(pp) )? 

  B) At individual level - Form 1040  -> somewhere in SCHEDULE D
  - this partner Depreciation Recapture = $600K 

                              ===> $1,200K/2 => line 25b -> Form 1065 -> Form 4797 / Part III / section 1245 property
  - this partner long term carryover loss = $550K
  - this partner taxable gain = $50K ==> $600K(gain) - $550K(carryover loss)
  - this partner tax obligation of sale = $12.5K ===> 25% of $50K(depreciation recapture)
  - this partner long term carryover loss, if applied above, would be $0.0 going forward
 
  Critical Questions:
  - at partner level the gain of $600K is depreciation recapture or ordinary income?
  - at partner level could the long term carryover loss offset depreciation recapture, if any?
  - at partner level could the long term carryover loss offset ordinary income, if any?
  - what is the bottom line tax implication given above scenario?

Please respond with your expert understanding of tax code in the area.

I am up against the wall since 4/17/2018 is fast approaching to discuss the right and correct strategy with the CPA

Thanks,

Mohammed Quadeer 

  

@Mohammed Quadeer

The only way you can get a valid second opinion is to pay a real estate accountant for a detailed review of your situation. None of us can do it here on this forum.

Originally posted by @Mohammed Quadeer :
The critical question is:  Could long term carryover loss offset depreciation recapture after sale of investment property at loss?

"Long tern carryover loss" doesn't tell us what it is.  I assume you are talking a long term capital loss carryover and if so, NO, it will not offset depreciation recapture.  You will be stuck with the $3k per year until you have a capital gain to offset it.  

You have a lot of money involved - pay someone for advice.  You aren't going to find a good CPA on here giving out free tax calculations 3 weeks before the tax deadline.

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