We just sold an investment property that was bought using a 1031 exchange. So there was a previous rental property that was depreciated before it was sold. On that property, we made a large profit; on the second property (the one we just sold), we had a loss.
1. Estimated tax: Your tax due, including the sale, will be less than without the sale. So if your withholding if sufficient for your other income you won't need to pay any estimated tax.
The above bold statement is very likely not true. I understand why MDM would say it based on the facts presented, but (s)he's likely either not familiar with 1031 exchanges or one of us isn't understanding your facts properly. 1031 exchanges are complex, so I'm not surprised.
I've dealt with a dozen or so of these in my time preparing tax returns, so I have some experience but I'm certainly not an expert in the area. Here is an example, which should help explain why you will likely owe some tax:
Property 1 - Purchase Price = $200,000 in 1995. Sale price = 300,000 in 2006. Due to 11 years of depreciation, the cost basis of #1 is about $115,000. This means you have a gain of $185,000, but you did a 1031 exchange (like kind exchange) which means this gain was tax free and rolled into the new deal.
Property 2 - Purchase Price = $500,000 in 2006, but you rolled the $185,000 gain into this deal, so now your tax cost basis is only $315,000. You then depreciate this $315,000 for another 8 years, so your basis is roughly $225,000. Now you say you sold property 2 at a loss, but you likely mean you sold it for less than what you paid for it right? So let's assume you sold it for $450,000 which looks like a $50,000 loss, but for tax purposes it's actually a gain of $225,000.
So Ozzie, the answer to your question of figuring out depreciation is to look at the tax return from 2 years ago prepared by a professional. If they were kind enough to include depreciation schedules you will need to follow whatever they say. Hopefully when doing your return for the last 2 years you followed the same treatment.
The listed purchase price of property 2 (net of 1031 exchange gain), less accumulated depreciation since the purchase, is your cost basis. The difference between the sale price of property 2 and your cost basis is a gain. Some of it might be taxed as a capital gain, but it's more likely that a large part is subject to depreciation recapture, which means it will be taxed at ordinary rates.
If you're worried about not paying penalties and interest, just pay 110% of your 2013 tax via withholdings and quarterly estimates during 2014. This won't prevent a large balance due in April 2015, but it will at least keep the total cost as low as possible. If you're more interested in paying in quarterly tax estimates to cover the entire gain, you need to calculate the gain first (don't just add the sale price as income as TurboTax suggested). Either way, for 2014 I suggest you hire a professional. This is not something you should DIY. I'm all for most people preparing their own return, but this is complex and the IRS might audit the transaction due to the complexity. Play it safe and pay someone $500-1,000 to get this done properly. The peace of mind will be worth the money.
