Author Topic: Tax implications related to depreciation  (Read 2523 times)

GorgeousSteak

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Tax implications related to depreciation
« on: May 06, 2015, 01:59:54 PM »
I'm trying to figure out how taxes will work when i sell my rental, not exactly, but trying to ballpark it.  I tried various internet searches, but its a little too confusing for me to piece together.  I've got a condo I bought in 2006 for 350K, converted it to a rental in 2011 (at this point it was worth about 225K, although I don't think this is relevant).  Been renting ever since, probably worth now about 325K.  I've been claiming the depreciation on my taxes each year, it looks like for last year, i claimed 5500 here (just sort of letting turbo tax handle this).  Do I take the 350K, subtract off all the depreciation i've claimed (lets say 5500 * 4 years = 22K) so this gets it to 328K, and then compare that against what I get for selling it.  So, in this case (ignoring all fees), I get -3K and pay no capital gains?

Am I understanding this correctly?

SuperSecretName

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Re: Tax implications related to depreciation
« Reply #1 on: May 06, 2015, 02:06:33 PM »
following.  I am in a very similar situation, but still underwater.  won't be able to sell for many years still.

zephyr911

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Re: Tax implications related to depreciation
« Reply #2 on: May 06, 2015, 02:54:06 PM »
Yes, you subtract depreciation from your cost basis and that gives you an adjusted basis. Subtract your adjusted basis from your selling price and that is your capital gain or loss.

I strongly recommend you go through your HUD-1 from when you bought the home and do a line-by-line analysis to determine what goes into your basis and what doesn't. Don't just assume that the total amount due was your basis, since some of those costs are expensed in the year of purchase (like prepaid interest/taxes/insurance) while others are actually transactional costs that add to basis. And if you made any improvements (as opposed to repairs) those all need to be added to the basis (and depreciated) as part of the gain/loss computation.

Frankly, I hate having to do this kind of thing so I just plan on holding all my rentals forever. ;)

GorgeousSteak

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Re: Tax implications related to depreciation
« Reply #3 on: May 06, 2015, 03:06:28 PM »
Hmm, could be interesting digging up the HUD from 2006.  What kinds of significant things don't count towards the basis?  Kind of unfortunate because I was young and relatively foolish and had no idea I was going to rent it out.  So, my bookkeeping on these types of things is going to spotty.  I did make probably 20K worth of improvements to the property before we started renting it out.  I might be able to dig up receipts for some of this stuff but its going to be tough.  If I can't find receipts am I SOL in factoring this in to the basis?  If I have pictures of it from when I bought and when I sell it that clearly show the improvements, is this not good enough with my reasonably good estimate of what it cost not good enough?

I can see how renting it forever simplifies things.  But we're roughly cash flow neutral and don't like being landlords, so we really just need to exit now that the price has bounced back and are no longer underwater.  The math becomes even worse once we start taking the capital gains tax hit which is why I'm trying to do these calculations.  If my tax return says I'm taking 5500 depreciation a year, @ 15%, that about 68.75 / mo we loose to this once we cross the threshold.

zephyr911

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Re: Tax implications related to depreciation
« Reply #4 on: May 06, 2015, 03:19:48 PM »
Hmm, could be interesting digging up the HUD from 2006.  What kinds of significant things don't count towards the basis?  Kind of unfortunate because I was young and relatively foolish and had no idea I was going to rent it out.  So, my bookkeeping on these types of things is going to spotty.  I did make probably 20K worth of improvements to the property before we started renting it out.  I might be able to dig up receipts for some of this stuff but its going to be tough.  If I can't find receipts am I SOL in factoring this in to the basis?  If I have pictures of it from when I bought and when I sell it that clearly show the improvements, is this not good enough with my reasonably good estimate of what it cost not good enough?

I can see how renting it forever simplifies things.  But we're roughly cash flow neutral and don't like being landlords, so we really just need to exit now that the price has bounced back and are no longer underwater.  The math becomes even worse once we start taking the capital gains tax hit which is why I'm trying to do these calculations.  If my tax return says I'm taking 5500 depreciation a year, @ 15%, that about 68.75 / mo we loose to this once we cross the threshold.
Yeah, it sounds like you probably should get out. I too became a landlord initially by accident and need, but I had wanted to do it for a long time and it turned into a series of investments that each worked out better than the last. If you're not making money and you don't enjoy it, cut it off and put your funds into things that work better for you.

You will only need receipts if you are audited for the year you sell. That said, I strongly suggest pursuing all avenues to reconstruct your records as well as possible, simply for completeness. I often short-change myself when I guess, because little things add up to large amounts. Be very careful to differentiate repairs and improvements. Replacing shingles is a repair (a deductible expense in that year); replacing a roof is an improvement (it adds value and it depreciates on the same schedule as the home itself, but with a different start date). Any improvements done before placing the rental in service should be added to the initial cost basis, adding to depreciation.

***NOTE***
If you find that you didn't start with the full cost basis for depreciation, you should adjust it based on the improvements, which will also increase your allowed depreciation (starting when the home was placed in service as a rental). The IRS says to use the total depreciation you should have claimed (not what you did claim) when calculating capital gains, so check this ASAP and make sure you claim the full amount going forward. Any differential there (for past years) is lost unless you go back and amend the returns.

As far as what is/isn't added to basis: I don't maintain full knowledge of it, because I so rarely need to know. This year I went line by line and Googled every single one that I wasn't sure about :D

If you don't have your HUD-1, the venue where you closed should have an archive copy, or the bank might.

GorgeousSteak

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Re: Tax implications related to depreciation
« Reply #5 on: May 06, 2015, 03:41:48 PM »
Ok, I was confused why my depreciation number was lower than I thought it should be.  I just found this on the turbotax website:

"If you are converting your property from personal use to rental use, your tax basis in the property is calculated differently. Your basis is the lower of these two:

*Your acquisition cost
*The fair market value at the time of conversion from personal to rental use"

So, when I converted, the property was at its lowest price (225Kish).  So, this means i'm on the hook for a full 100K of appreciation for taxes?  That doesn't seem to make sense to me.  My loss of 125K from when i purchased it to when I converted it to a rental would have just vanished.  Anyone have insight into this?

GorgeousSteak

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Re: Tax implications related to depreciation
« Reply #6 on: May 06, 2015, 04:10:19 PM »
Alright, I realize I'm mostly just talking to myself at this point, but others might be interested.  As most tax questions go, this is quite a bit more complicated than it seems like it should be.  This seems to provide an understandable explanation:http://www.marketwatch.com/story/tax-angles-when-converting-your-home-into-a-rental-2013-05-14.  My panic about being on the hook for the 100K gain seems to be unfounded.  As you use the "regular basis" (original cost of property + improvements - depreciation) compared against sale price when determining the loss on the sale.  Looks like I still have a few years (highly dependent on property value changes obviously) before I cross the threshold of paying capital gains.

Arktinkerer

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Re: Tax implications related to depreciation
« Reply #7 on: May 07, 2015, 11:10:49 AM »
If you sell for more than the cost-depreciation then there is reclaimed depreciation for which you are taxed 25%.  I don't know if you are then taxed again on that as long term capital gain?  I don't think this hits your example since you are saying you will sell for less than the depreciated value.

zephyr911

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Re: Tax implications related to depreciation
« Reply #8 on: May 11, 2015, 10:11:28 AM »
Alright, I realize I'm mostly just talking to myself at this point, but others might be interested.  As most tax questions go, this is quite a bit more complicated than it seems like it should be.  This seems to provide an understandable explanation:http://www.marketwatch.com/story/tax-angles-when-converting-your-home-into-a-rental-2013-05-14.  My panic about being on the hook for the 100K gain seems to be unfounded.  As you use the "regular basis" (original cost of property + improvements - depreciation) compared against sale price when determining the loss on the sale.  Looks like I still have a few years (highly dependent on property value changes obviously) before I cross the threshold of paying capital gains.
Right, so it reduces the depreciation you can claim but doesn't reduce your basis. I just learned something new. This wouldn't affect my own cases since the rentals were converted within a few years at essentially the same market value, but I will have to keep it in mind for the future.