Questions for any CPA's regarding Capital Gains/Loss on Rental Propery

[FelixUnder]

This pertains to a property purchased as main home and converted to a rental. I don't qualify for the 2 years in 5 rule.

This article is from Marketwatch from 2013. I can't find anything like this in the IRS Publications that I've read.
http://www.marketwatch.com/story/tax-angles-when-converting-your-home-into-a-rental-2013-05-14


Do you know if this tax law still exists?

Different Basis Rules Can Produce Weird Tax Results When Property Is Sold
When you sell the converted property, the tax results might be surprising. That is because you must use the special basis rule to determine if you have a deductible loss on sale, but you must use the regular basis rule to determine if you have a taxable gain. Following two different basis rules can sometimes put you in no man’s land where you have neither a taxable gain nor a deductible loss. In fact, that is exactly what will happen whenever the sale price falls between the two basis numbers. I know this is confusing, so here are some examples.

Example 1: No Tax Gain and No Tax Loss on Sale
Your converted property is in a market that has bounced off the bottom but not all the way back to its earlier peak by the time you sell. Assume the following numbers for the property.

• 1. Regular basis on conversion date: $300,000
• 2. FMV on conversion date: 235,000
• 3. Post-conversion depreciation deductions: 13,000
• 4. Special basis for tax loss (line 2 – line 3): 222,000
• 5. Regular basis for tax gain (line 1 – line 3): 287,000
• 6. Net sale price: 275,000
• 7. Tax loss (excess of line 4 over line 6): none
• 8. Tax gain (excess of line 6 over line 5): none

Explanation: Because the sale price falls between the two basis numbers, you have no tax gain and no tax loss. Strange but true!

 

[FelixUnder]

This pertains to a property purchased as main home and converted to a rental. I don't qualify for the 2 years in 5 rule.

This article is from Marketwatch from 2013. I can't find anything like this in the IRS Publications that I've read.
http://www.marketwatch.com/story/tax-angles-when-converting-your-home-into-a-rental-2013-05-14


Do you know if this tax law still exists?

Different Basis Rules Can Produce Weird Tax Results When Property Is Sold
When you sell the converted property, the tax results might be surprising. That is because you must use the special basis rule to determine if you have a deductible loss on sale, but you must use the regular basis rule to determine if you have a taxable gain. Following two different basis rules can sometimes put you in no man’s land where you have neither a taxable gain nor a deductible loss. In fact, that is exactly what will happen whenever the sale price falls between the two basis numbers. I know this is confusing, so here are some examples.

Example 1: No Tax Gain and No Tax Loss on Sale
Your converted property is in a market that has bounced off the bottom but not all the way back to its earlier peak by the time you sell. Assume the following numbers for the property.

• 1. Regular basis on conversion date: $300,000
• 2. FMV on conversion date: 235,000
• 3. Post-conversion depreciation deductions: 13,000
• 4. Special basis for tax loss (line 2 – line 3): 222,000
• 5. Regular basis for tax gain (line 1 – line 3): 287,000
• 6. Net sale price: 275,000
• 7. Tax loss (excess of line 4 over line 6): none
• 8. Tax gain (excess of line 6 over line 5): none

Explanation: Because the sale price falls between the two basis numbers, you have no tax gain and no tax loss. Strange but true!

Thought we had a few CPA's on the forum. Anybody? Anybody who has rental properties with experience selling a converted property?

 

[Jstack34]

https://www.irs.gov/pub/irs-pdf/p544.pdf

I think Page 4 confirms this still exists

 

[FelixUnder]

https://www.irs.gov/pub/irs-pdf/p544.pdf

I think Page 4 confirms this still exists

I saw this publication earlier and I didn't think it confirmed the "No Loss No Gain" scenario. But after reading it over just now, maybe you're right. I'm confused on the depreciation used to come up with the adjusted basis as well. I thought only the structure could be depreciated, not the land. But I've been reading that to calculate the adjusted basis, you have to deduct the depreciation and to do that you have to divide the purchase price by 27.5 and subtract that from the purchased price. And you have to do that whether or not you have been using depreciation on your returns. That doesn't make any sense as that would reduce the basis drastically within just a few years which would result in a large capital gain even if the property didn't go up in value. Very confusing.

 

[FelixUnder]

Jstack, thanks for your response by the way.

 

[Jstack34]

I saw this publication earlier and I didn't think it confirmed the "No Loss No Gain" scenario. But after reading it over just now, maybe you're right. I'm confused on the depreciation used to come up with the adjusted basis as well. I thought only the structure could be depreciated, not the land. But I've been reading that to calculate the adjusted basis, you have to deduct the depreciation and to do that you have to divide the purchase price by 27.5 and subtract that from the purchased price. And you have to do that whether or not you have been using depreciation on your returns. That doesn't make any sense as that would reduce the basis drastically within just a few years which would result in a large capital gain even if the property didn't go up in value. Very confusing.

Yes, you have to do that whether you have been depreciating it or not because you should have been taking a deduction for that the entire time. It has been reducing your rental gain each year. To get depreciation, you need to divide the value of the land by 27.5 - so you need to figure what relates to land and what relates to building. A lot of accounting firms take the position that 80% is attributed to building and 20% to land in order to make it simple.

Is there a reason you wouldn't have been depreciating on the return? If so, you are missing out on a pretty big deduction each year.

 

[ThreeKings]

When the property is converted to rental you use the lower of original purchase price or current FMV for your basis. So now that your renting it you would allocate the basis between land and home with the home being depreciated over 27.5 year.

When you sell the property you would take sales price less adjusted basis (basis less depreciation plus closing costs) to determine if you have a gain or loss on the sale. If you have a loss you would have an ordinary deduction on your return. If you have a gain you get to look back at your original purchase price and if it is higher then the basis you used when you converted the property you can take the additional cost up to the gain amount, but not create a loss. If you have gain it would be taxed at capital gain rates. Which would include 1250 recapture for the amount of depreciation you have taken up to the gain amount. This is taxed at 25%, the rest of the gain would be taxed at 15 or 20% depending on your income. You also may subject to an additional 3.8 % tax on the gain.