Question

Mom sold her rental house in '19. Dep was $57k over the years, but taking dep every year NEVER gave her any tax savings since she only had SS income. Dep recapture tax?

Forum|Forum|6 years ago
September 5, 2019
2 replies
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If she never realized any tax advantages from taking the depreciation deduction then why should she have to pay the 25% dep recapture tax at sale? IRS won't help me until after 1/1/20, and two CPAs don't know the answer.

DoninGA

Employee

Whether any tax savings occurred or not from the depreciation of the rental property is not relevant. The depreciation must be recaptured when the rental property is sold.

See this website - https://www.investopedia.com/terms/u/unrecaptured-1250-gain.asp

Critter

Employee

She may have an NOL that is being carried on the books ... have a local tax pro review the returns she filed.

Hal_Al

Employee

NOL - Net Operating loss. That is, if she reported negative taxable income, in the years she filed. Those losses can be carried forward the year she sold the property.

"NEVER gave her any tax savings since she only had SS income".

That's possible, but unlikely. The depreciation reduced her net rental income, which reduced her gross and adjusted gross income, which reduced the amount of her social security that was taxable.

Carl11_2

Employee

taking dep every year NEVER gave her any tax savings since she only had SS income.

That's not quite accurate. The depreciation, along with other expenses such as property taxes, property insurance and other deductible rental costs most likely reduced the taxable rental income to zero. So if SS was her only other source of income, that would mean with no other taxable income, her SS income was totally tax free too. NOw if her taxable gain on the sale is below the threashold, she will pay taxes on the gain but will not pay taxes in the SS.

Depending on that AGI which would include half of her SS income and the taxable gains on the sale, if it's high enough then she "could" be taxed on a maximum of 85% of the SS income.

G

gotcha1222Author

The first part of your reply was correct. Over the years her income from the rental were only a few thousand dollars...not enough to where she had any taxable income. And even if I added back the depreciation in those years she still wouldn't have had any taxable income.

As far as the sale of her property, she doesn't get any capital gains exclusion (as her primary residence) since she didn't live in it at all over the past 6-7 years. So she's subject to capital gains tax on the $50k or so of gain, which I'm fine with. But it's the depreciation recapture tax that I'm not fine with. As I mentioned, she took $56k worth of depreciation deduction over the years, but even if she hadn't taken the deduction, she still wouldn't have had any taxable income, so it seems a bit unfair to be hit with that recapture tax since she never had any tax benefits in the first place. I called the IRS last month, but they won't answer a depreciation recapture question until January, as they say it's a "tax law" question, which are only answer Jan-April.

I

i931u

Hi,

Based on the information you provide I do not think your mom will end up paying capital gains on the $50k "gain". It is true that your mom will have to pay taxes on the gain of the property. However, how that gain is calculated is critical.

Step 1 : First to calculate the gain you have to take into account all the expenses She incurred to sell the property (sell commissions, improvements to get the property ready for sale, legal fees, utilities while the house was vacant, taxes, HOA fees, all the fees the title insurance charged and so on). Take a look at the Sale Settlement Statement of the property and you will find many of those charges. For example assume the following:

Property sold for $132,000

Property bought for $120,000 in 2009 (10 years ago)

Depreciation so far: $57,000

Total sale expenses: $18,000 as follows:

1. Real Estate Broker Commission: $8,000

2. 2018 taxes: $2,000

3. 2019 taxes up to the day of sale: $1,000

4. Title company fees: $1,500

5. Home Owners Assoc Fees: $500

6. Repairs to get the property ready for sale (paint, cleaning, carpet, general repairs): $5,000

Your gain would be: $132k (property sale price) - $18k (Sale expenses) - $63k (value of the depreciated property see calculation below) = $51k (this is your gain)

Value of the depreciated property = purchase price in 2009 - depreciation = $120k - $57k = 63k

Step 2: Whatever gain you end up with will be offset with the accumulated loss your mom has incurred in the property all these years. Here is an example

- Year 1: Rental Income: $8,000 - Property Taxes: $2,000 - Insurance $1,200 - Repairs: $600 - Mortgage Interest: $1,500 - Depreciation ($5,000) = Loss of $2,300 which based on your mom's situation was a disallowed loss so it will be carried over to next year.

- Year 2: Rental Income: $8,000 - Property Taxes: $2,000 - Insurance $1,200 - Repairs: $600 - Mortgage Interest: $1,500 - Depreciation ($5,000) = Loss of $2,300 which based on your mom's situation was a disallowed loss so it will be carried over to next year. Y1 + Y2 disallowed losses = 2,300 + 2,300 = 4,600

- Year 3 (assuming same rental income and expenses) = loss of 2,300 and a the accumulated loss to carry over to year 4 would be $6,900

After 10 years the property would generate an accumulated loss of around $23,000. This accumulated loss will reduce the gains calculated in step 1. So if your gains from step 1 were $51k. Then you would pay taxes on only $51k - $23k = $28k.

It is very likely that your mom (or her accountant) were not carrying over the loss on the property to next year return or were not calculating the loss properly every year.

You are correct that many accountants are not familiar on how to reduce the impact of taxes with investment properties.

In the future if your mom wants to avoid recapture depreciation and capital gains taxes when selling real estate She will need to do a 1031 exchange with the property.

I hope this helps.