Rental RE tax form question

[MrGreen]

We're about to sell our former home. It's been a rental since 2017. I've been filling out a set of 2023 tax forms like a mock 2024 tax filing so I know what to expect come tax time. It looks like Form 4797 - Sales of Business Property is where we account for the sale of the rental. The rental is a Section 1250 asset so it goes in Part III. Line 21 appears to be where we account for "Cost or other basis plus expense of sale."

Is that really it? One figure on one line is all the IRS wants to see for my basis calculation, which includes initial cost basis and purchasing costs, improvements prior to being converted to a rental, and sale costs? I guess I'm just surprised that I'm going to put a figure there and that's all she wrote. Obviously if they audit us we'll have to show all the paperwork backing up the calculation but I guess I thought there would be more? To anyone that has sold investment RE before, does this sound right?

[SeattleCPA]

We're about to sell our former home. It's been a rental since 2017. I've been filling out a set of 2023 tax forms like a mock 2024 tax filing so I know what to expect come tax time. It looks like Form 4797 - Sales of Business Property is where we account for the sale of the rental. The rental is a Section 1250 asset so it goes in Part III. Line 21 appears to be where we account for "Cost or other basis plus expense of sale."

Is that really it? One figure on one line is all the IRS wants to see for my basis calculation, which includes initial cost basis and purchasing costs, improvements prior to being converted to a rental, and sale costs? I guess I'm just surprised that I'm going to put a figure there and that's all she wrote. Obviously if they audit us we'll have to show all the paperwork backing up the calculation but I guess I thought there would be more? To anyone that has sold investment RE before, does this sound right?

Regarding your basis calculations (the part I boldfaced above), you need to also include your depreciation... and obviously some of the property may not be Section 1250 (the real estate) but personal property (e.g., appliances).

[MrGreen]

We're about to sell our former home. It's been a rental since 2017. I've been filling out a set of 2023 tax forms like a mock 2024 tax filing so I know what to expect come tax time. It looks like Form 4797 - Sales of Business Property is where we account for the sale of the rental. The rental is a Section 1250 asset so it goes in Part III. Line 21 appears to be where we account for "Cost or other basis plus expense of sale."

Is that really it? One figure on one line is all the IRS wants to see for my basis calculation, which includes initial cost basis and purchasing costs, improvements prior to being converted to a rental, and sale costs? I guess I'm just surprised that I'm going to put a figure there and that's all she wrote. Obviously if they audit us we'll have to show all the paperwork backing up the calculation but I guess I thought there would be more? To anyone that has sold investment RE before, does this sound right?

Regarding your basis calculations (the part I boldfaced above), you need to also include your depreciation... and obviously some of the property may not be Section 1250 (the real estate) but personal property (e.g., appliances).

I'm not in front of the form anymore but depreciation was the next line I think, Line 22. Calls it out separately so I can be directed to add it to ordinary income vs. capital gains.

Thank you for the reminder about appliances! I need to figure out what, if anything, I'm allowed to do about partially depreciated appliances. I assume the answer is I just lose that, but you know what they say about assumptions!

[SeattleCPA]

We're about to sell our former home. It's been a rental since 2017. I've been filling out a set of 2023 tax forms like a mock 2024 tax filing so I know what to expect come tax time. It looks like Form 4797 - Sales of Business Property is where we account for the sale of the rental. The rental is a Section 1250 asset so it goes in Part III. Line 21 appears to be where we account for "Cost or other basis plus expense of sale."

Is that really it? One figure on one line is all the IRS wants to see for my basis calculation, which includes initial cost basis and purchasing costs, improvements prior to being converted to a rental, and sale costs? I guess I'm just surprised that I'm going to put a figure there and that's all she wrote. Obviously if they audit us we'll have to show all the paperwork backing up the calculation but I guess I thought there would be more? To anyone that has sold investment RE before, does this sound right?

Regarding your basis calculations (the part I boldfaced above), you need to also include your depreciation... and obviously some of the property may not be Section 1250 (the real estate) but personal property (e.g., appliances).

I'm not in front of the form anymore but depreciation was the next line I think, Line 22. Calls it out separately so I can be directed to add it to ordinary income vs. capital gains.

Thank you for the reminder about appliances! I need to figure out what, if anything, I'm allowed to do about partially depreciated appliances. I assume the answer is I just lose that, but you know what they say about assumptions!

The depreciation isn't actually ordinary income. It's "unrecaptured Section 1250 gain" taxed at 25%. So sort of like capital gains. Kind of.

[MrGreen]

We're about to sell our former home. It's been a rental since 2017. I've been filling out a set of 2023 tax forms like a mock 2024 tax filing so I know what to expect come tax time. It looks like Form 4797 - Sales of Business Property is where we account for the sale of the rental. The rental is a Section 1250 asset so it goes in Part III. Line 21 appears to be where we account for "Cost or other basis plus expense of sale."

Is that really it? One figure on one line is all the IRS wants to see for my basis calculation, which includes initial cost basis and purchasing costs, improvements prior to being converted to a rental, and sale costs? I guess I'm just surprised that I'm going to put a figure there and that's all she wrote. Obviously if they audit us we'll have to show all the paperwork backing up the calculation but I guess I thought there would be more? To anyone that has sold investment RE before, does this sound right?

Regarding your basis calculations (the part I boldfaced above), you need to also include your depreciation... and obviously some of the property may not be Section 1250 (the real estate) but personal property (e.g., appliances).

I'm not in front of the form anymore but depreciation was the next line I think, Line 22. Calls it out separately so I can be directed to add it to ordinary income vs. capital gains.

Thank you for the reminder about appliances! I need to figure out what, if anything, I'm allowed to do about partially depreciated appliances. I assume the answer is I just lose that, but you know what they say about assumptions!

The depreciation isn't actually ordinary income. It's "unrecaptured Section 1250 gain" taxed at 25%. So sort of like capital gains. Kind of.

25%?! Why the hell would anyone ever want to take depreciation? We'd have to have an income of almost 400k before depreciation would "save" on taxes in any given year if we knew it had to be recaptured at the end at 25%. I know it's not a choice, but why would anyone have ever thought that was advantageous in the first place?

Edit: Wait a minute. Now that I'm reading the Form 4797 instructions more closely it says that depreciation recapture does not apply to MACRS property using the 27.5 year depreciation schedule. That's our rental since it went into service in 2017. If I follow the instructions, I enter nothing for depreciation of Section 1250 property and when I complete the rest of the form my entire gain is treated as a long-term capital gain. Now I'm confused since I thought depreciation recapture was unavoidable.

[uniwelder]

I’m confused too. Everything I read says depreciation recapture is taxed at a maximum of 25%, but I can’t find anything that provides tax brackets or situations where you might pay less than 25%.

Up until now, I always assumed depreciation recapture was just included as part of long term capital gains. I’m glad to be following along here.

[MrGreen]

I’m confused too. Everything I read says depreciation recapture is taxed at a maximum of 25%, but I can’t find anything that provides tax brackets or situations where you might pay less than 25%.

Up until now, I always assumed depreciation recapture was just included as part of long term capital gains. I’m glad to be following along here.

When I Google this, ALL the websites I can find talk about depreciation recapture like it's an absolute. But the instructions say what they say. Form 4797 itself even has a note under Line 26 that says if straight line depreciation was taken then enter 0 for Line 26g and move on. The effect of depreciation still lowers my basis but then the gain is all long-term capital gains, since there's no amount calculated for specific depreciation recapture. I've reread the instructions a dozen times now expecting to find some little blurb I missed but so far the text seems pretty clear to me. I'm hoping one of our resident CPAs will chime in and put me out of my misery. Lol

[MrGreen]

Okay, I understand what @SeattleCPA said now. I didn't complete enough of the forms. The depreciation figure on Form 4797 ends up on Schedule D as an "unrecaptured Section 1250 gain" and does indeed appear to be taxed at 25%.

Here's what I don't understand. Why would I want to take depreciation in the first place? All these years we've been taking depreciation where our income is in the 12%/15% tax bracket and now we're "paying it back" at 25%? That has absolutely no value to me. Literally the opposite, in fact. As I mentioned above, our income would have to be hundreds of thousands of dollar per year each year we take depreciation in order for a depreciation write off to actually save us money. I guess I can say goodbye to 10k I'm just now realizing we're going to owe in federal taxes.

Okay, I just completed a mock Unrecaptured Section 1250 Gain Worksheet and Schedule D Tax Worksheet and it would appear that our income has to be over a certain amount for the 25% unrecaptured gain tax rate to kick in. In this year, ours is not. This house sale is 90% of our income for the year with ~50% of it being long-term capital gains and ~50% of it being depreciation recapture. The worksheets give me the same "total taxes owed" result that I had figured previously when I thought depreciation recapture could be taxed as ordinary income. It's late and my brain is fried now so I'm going to look all this over again tomorrow but it would seem my sudden concern of a 25% tax bill on $46,000 in depreciation recapture is unwarranted.

[SeattleCPA]

I'm only episodically seeing this forum. So sorry for the "drive-by" nature of my comments. But to be technical, the "reversal" of the depreciation on the 27.5-year stuff isn't depreciation recapture. It's "Unrecaptured Section 1250" gain taxed at rates up to 25%. So that technical definition confusion may be partly what's going on here.

The recapture stuff is the personal property depreciation basically. Aka Section 1245. That's taxed as ordinary income.

BTW the true appreciation gain is Section 1231 gain. That's not really Section 1221 long-term capital gains. But it's mostly treated that way.

Tip: Use software to do your calculations.

[uniwelder]

Here's a copy/paste from another thread that included a link to Turbotax where depreciation is explained very well.  I thought it would be worth posting back to this thread.  Also, how does one do the bat signal for @Mr. Green?
https://forum.mrmoneymustache.com/ask-a-mustachian/counting-rental-property-equity-toward-our-retirement-savings/

Then it seems I should count the equity as retirement savings if we're definitely going to sell it at some point and count the income as income for the years we'll rent it.(?)

But remember that you’ll lose part of that equity to capital gains taxes.  And if you’re depreciating the asset on your taxes today, you’ll be exposed to more capital gains.

This is true.  Your capital gains will be taxed at whatever your long-term capital gains rate is at the time of sale, but regardless of that, your depreciation recapture is always a flat 25%.  Make sure you are taking depreciation EVERY YEAR if you are eligible.  Some people don't wan't to mess with depression recapture so they never take it thinking that since they never took it, they'll never owe it...BAD MOVE.  Whether you ever take it or not, the Federal Government always assumes you are and you will have to pay it even if you never claimed it.

"Depreciation recapture is always a flat 25%"? I did a quick Google search and according to Turbo Tax, the depreciation recapture is capped at a maximum of 25%, not always a flat 25%.

https://turbotax.intuit.com/tax-tips/rental-property/depreciation-recapture-definition-calculation-and-examples/c5H96UGw8

If you sell the rental property in the first year of retirement and don't have any W-2 income, the first $89,251 of capital gains will be taxed at 0%, for a married couple. If you had 80,000 of ordinary income (after deductions), your first $9,251 worth of capital gains would be taxed at 0%. After that, it's 15%.

Thanks for the Turbotax link!  It has a great explanation of how depreciation is taxed, which has been a bit of mystery to me and others here.  There was another thread where @Mr. Green (if someone can figure out how to make the @ work properly for him, please let me know) was asking about depreciation recapture--- https://forum.mrmoneymustache.com/taxes/rental-re-tax-form-question/
I've tried looking up depreciation info before, but never seen it explained well.  Here's a copy/paste from their site of an example----

"You bought an office building five years ago for $2 million. Since then, you claimed depreciation deductions for the property totaling $256,000 using the straight-line method. You then sell the building for $2.1 million. The property’s adjusted basis when you sell it is $1.744 million ($2,000,000 - $256,000 = $1,744,000). That means you have $356,000 of gain ($2,100,000 - $1,744,000 = $356,000). You have no other gain or loss from the sale of business property.

Since the amount of gain exceeds the depreciation deductions, only $256,000 of the gain is treated as capital gain but taxed at the ordinary income tax rates up to a maximum of 25%. The remaining $100,000 of gain ($356,000 - $256,000 = $100,000) is treated as capital gain and taxed at the long-term capital gains tax rates (i.e., up to 20%)."

The person will pay regular income tax (up to 25%) on the depreciation, then pay long term gains tax on the amount exceeding the original purchase price (actually cost basis, which would include things like legal/realtor fees, repairs before being rented out, etc)

[MrGreen]

@uniwelder the bat signal for me works if it's spelled out just like my username, so I got yours. It doesn't look like it works though when you're typing it because the space breaks the username auto fill. Things I wish I knew when creating my name! There used to be a Mr. Green without the space but I see they're no longer so perhaps I should make that change while I can.

Thanks for linking the info! It matches what I learned when I finally filled out all the right  tax forms. This was incredibly helpful in me understanding what our taxes will look like at the end of the year and some steps I can take before the end of the year to help lower our tax burden. Looks like we'll be contributing to retirement accounts for the first time since we retired!

[MrGreen]

I just changed my username to eliminate the dot and space. A lot of people have mentioned the broken bat signal thing about my name so this is probably for the best!