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When selling a rental property is allocating proceeds to land and improvements legal?

Forum|Forum|5 years ago
October 6, 2020
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I cannot find anything in the tax code or any other independent sources that treat the sale of a rental property the same way turbo tax does. The sale of a rental property is the sale of a 1250 asset and I do not see where the tax code allows you to allocate a portion of the proceeds to land thereby reducing the depreciation recapture tax. Can anyone point me to an IRS publication or other resource?

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Best answer by M-MTax

Turbo tax does it that way BUT it doesn't matter whether you allocate to land or not....the whole thing comes out in the wash anyway where your entire depreciation deductions you took or should have taken are recaptured.

M-MTaxAnswer

Turbo tax does it that way BUT it doesn't matter whether you allocate to land or not....the whole thing comes out in the wash anyway where your entire depreciation deductions you took or should have taken are recaptured.

Y

yliggieAuthor

It did make a big difference. The property I sold was essentially a tear down and about 50% of my basis has been depreciated. It is in an area that saw substantial appreciation in the land values so I allocated 75% of the sale proceeds to land and 25% to improvements. The 25% allocated to improvements did not exceed my deprecated basis so I had no recapture tax. If I allocate more of the proceeds to improvements then the gain exceeds the basis and I have to pay recapture tax. I can justify the larger allocation to land as nearby vacant land has sold for similar prices as my property with improvements but I'm just not convinced it is allowed.

A local CPA told me, "When you sell real property, you must sell both property and land together. You cannot split the proceeds and sell the land and property separately to avoid depreciation recapture. Sorry." I typically trust turbotax but I'm concerned on this one.

M-MTax

OK, so to take this to an insane level what if my rental house is fully depreciated and I sell it for $500k.....years ago I allocated $50k to land and $200k to the building. Like you my land has appreciated substantially and now has a FMV of $400k. Can I allocate $400k of the sales price to land and $100k to the building? What happens to the other $100k worth of depreciation deductions I took over the years?

A

Anonymous

I take a different position. the sales price should be allocated to each asset (land, building and improvements) based on there relative Fair Market Value at the time of sale. Admittedly this is easier said than done because it's virtually impossible (short of a component appraisal) to determine what the FMV is today of say an electrical upgrade that was done 10 years ago. TT really can't handle very well situations like this.

I've seen CPA firms handle a situation like yours in multiple ways after discussion with the client. This not make it right. Usually, they have an advantage in that their software is more sophisticated and allows them to do things not possible in TT.

1) do a mass disposition - all the assets costs including land are lump together as 1 asset and the related depreciation is combined so the 4797 shows only the sale of 1 asset. thus any gain first goes to depreciation recapture and then the excess is capital gain

2) all or certain components are allocated a sales price and cost of sale so there is no gain or loss. the rest is allocated to land and building (even how this is done varies from situation to situation)

do whatever you want, but TT does not guarantee accuracy as to allocations determined by client input.

M-MTax

Well that 'mass disposition', IMO, is the best because the proceeds will line up with the 1099S form that the seller's going to receive from the closing company and it allows for full recapture of total depreciation deductions taken.