Taxable gain on sale of formerly rented house?

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This topic contains 16 replies, has 3 voices, and was last updated by  kaneohe 2 months, 2 weeks ago.

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  • #3564

    fairira
    Participant

    A single, former California resident has been renting his house and has taken depreciation on his Schedule E each year.

    He plans to return to California but does not yet know if he will resume living in that house. If he does live there for 2 years so he can exclude $250,000. of capital gain and then sells the house, what basis would he use to calculate his capital gain and how would unrecaptured depreciation enter into this?

    What would taxable gain be if house was purchased for $125,000., total depreciation taken is $17,400. and house sells for $400,000.

    Thank you for any helpful information.

    #3566

    kaneohe
    Participant

    https://www.kitces.com/blog/limits-to-converting-rental-property-into-a-primary-residence-to-plan-for-irc-section-121-capital-gains-exclusion/

    might be interesting to read……..first order guess is that the basis
    is the initial basis less depreciation. Looks like the max gain exclusion of 250K gets prorated based on yrs lived there
    vs total yrs owned and the depreciation recapture remains.

    If basis is 125K less depreciation; then gain is 275K + depreciation.
    If exclusion is 250K – proration adjust, then taxable gain is 25K +proration adjust + depreciation . Also have to consider the usual capital improvements and transaction fees.

    Hopefully somebody who really knows this stuff will be along later but try reading the link for a start.

    #3567

    fairira
    Participant

    Kaneohe,

    Thank you for your very helpful comments and link.

    I’ll try to find out if there have been any more changes since the article in the link is now 5 years old.

    Re the tax on a future house sale if he lives in it for 2 years: I assume he could elect to include at least $25,000. in capital gain as investment income in line 4g of Form 4952 (Net Investment Interest Expense). Could he do this also with the added proration adjustment to his gain and/or with the unrecaptured depreciation of $17,400.?

    Thanks again.

    #3569

    kaneohe
    Participant

    I’ve never done F4952 but just looking at the line 4a)
    “4 a Gross income from property held for investment (excluding any net
    gain from the disposition of property held for investment)”

    suggest that the income they are looking for is “operating” income…..not
    from the sale of property?

    #3571

    fairira
    Participant

    Kaneohe,

    I’m sure you’re correct about line 4a of Form 4952. I had referred to line 4g but should have said that at least $25,000. in capital gain would be first entered in line 4d (Net gain from the disposition of property held for investment). In turn that would lead to the same entry amount in line 4g if the house owner elects to treat the capital gain as investment income.
    ———————————————————-
    The line 4g instructions are: “In general, qualified dividends and net capital gain from the disposition of property held for investment are excluded from investment income. But you can elect to include part or all of these amounts in investment income.

    “CAUTION
    “The qualified dividends and net capital gain that you elect to include in investment income on line 4g aren’t eligible to be taxed at the qualified dividends or capital gains tax rates.”
    ———————————————————
    I would like to use your comments to try to make correct calculations and I will include some numbers and dates to help calculate the pro rata treatment of the capital gain.

    As you noted, “If basis is 125K less depreciation; then gain is 275K + depreciation.” Thus the house basis would be the purchase cost of $125,000. – $17,400. depreciation = $107,600. Then the gain is $275,000. + $17,400. depreciation = $292,400.

    The house was the owner’s primary residence for 2-1/2 years from July 2006 to January 2009 (when it became rental property) and it will be again for 2 years from January 2020 to February 2022 when it will be sold, a total of 4-1/2 years of primary residence and 11 years of nonqualifying use.

    As you also noted, “If exclusion is 250K – proration adjust, then taxable gain is 25K + proration adjust + depreciation.” The exclusion is reduced to $250,000. – 11/15.5 x $250,000. (proration adjust) = $72,581. Boo-hoo! Then the taxable gain is $25,000. + $177,419. + $17,400. depreciation+ = $219,819. Double boo-hoo!

    Of the $219,819. taxable gain, the depreciation recapture will result in $17,400. being taxed separately at a maximum rate of 25%. The regular capital gains tax rate would apply to the remaining $202,419. or it could be entered on lines 4d and 4g of Form 4952 with an election to take it as investment income that would be fully offset by a larger amount of investment interest expense the house owner accrued in prior years.

    Thank you for your help and any further comments about the foregoing would be much appreciated.

    #3572

    kaneohe
    Participant

    fairira………..I agree that your calculations agree w/ my idea of how things might work. Whether that idea is correct or not remains to be seen. Hopefully you will follow up on your idea to check if anything
    has changed since that linked article and hopefully someone else will
    see your post here.

    You were also correct that I missed your line # 4g. Got so excited
    about finding line 4a that I didn’t look further. And you are correct
    about the option to treat CG as CG or ordinary income on F4952……..I just learned that last wk on another forum (and then forgot it).

    #3573

    kaneohe
    Participant

    https://www.irs.gov/pub/irs-pdf/p523.pdf

    Found this wksht 3 on p.15……..looks like it still has the proration for non-use for 2018 tax yr and looks like the non-qualifying started
    in 2009 just when your example started the rental. Nice publication tho………lots of wkshts that appear to lead you thru the process.

    #3575

    fairira
    Participant

    Kaneohe,

    Many thanks for your very helpful posts.

    As an incidental note, I have also read that the unrecaptured depreciation can be taken as ordinary income in Form 4952.

    #3576

    kaneohe
    Participant

    Interesting……seems a bit weird tho………when you use QDIV/LTCG
    against investment interest, you give up a lower rate that is countered
    by a deduction . For the unrecaptured depreciation, don’t you get
    both ends of the bargain, a lower rate on the recapture as well as the investment interest deduction? Guess it depends on your ordinary income rate vs the recapture rate.

    #3579

    fairira
    Participant

    Kaneohe,

    Your comment points out some of the pros and cons of using QDIV/LTCG against investment interest carryover. If this house owner did not have a very large amount of accrued investment interest expenss, he would probably just pay the regular income tax on his capital gain from his future house sale.

    Thanks again for your help.

    #3592

    snargle
    Participant

    I’m pretty sure that it’s the actual gain and not the exclusion of the gain that gets “apportioned” based on the time the house was, and the time it wasn’t, used as a principal residence.

    See the provision for “periods of nonqualified use” in IRC Section 121(b)(5).

    #3612

    snargle
    Participant

    My explanation just above should have read “it’s the actual gain and not the excludable amount of the gain that gets “allocated” based on the length of time the house was, and the length of time it wasn’t, used as a principal residence, and some other factors, too.”

    #3616

    kaneohe
    Participant

    snargle………..I believe you might be correct and I misinterpreted the links. Hopefully OP returns and sees your posts. I can’t a way to PM the OP……….are you aware of how to do that? If there isn’t, that’s a serious limitation .

    Do you agree that since the maximum exclusion (250K) and gain (400K – 125K)= 275K are “similar”, the end results will also be “similar”so there won’t be a major change in the end result?

    • This reply was modified 3 months ago by  kaneohe.
    #3657

    snargle
    Participant

    “Do you agree that since the maximum exclusion (250K) and gain (400K – 125K) = 275K are “similar,” the end results will also be “similar” so there won’t be a major change in the end result?” asks kaneohe.

    Yeah, but even though the answers will be “similar” I would point out that one of the answers would be correct, while the other one would not be. Sorta like, they would be distinctly *unsimilar* in that regard… 🙂

    #3663

    kaneohe
    Participant

    ok, thanks, just checking……..depending on whether OP went away w/ just the bottom line number answer or the “theory” behind it, there might be lasting harm or not. Trying to get Kaye to notify OP so OP can return and be educated by your posts.

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