*SALE OF A RENT HOUSE*
John Q. Taxpayer bought a condo with the intent of having his children live in it while they were going to college. The idea was to rent part of it to other students, minimize the cost of living expenses for his children and make a big profit after their graduation by selling the condo at an appreciated price.
IT DIDN’T WORK OUT AS PLANNED
Unfortunately a lot of other parents had the same idea and the values did not appreciate.
Furthermore, depreciation and maintenance costs attributable to the rental portion exceeded the amount of rent collected.
PHASE-OUT RULES RESULT IN POSTPONING TAX DEDUCTIONS
A tax deductioin? No, not yet. Unfortunately for J.Q. there is a “soak the rich” provision that phases out deductions for rental losses if your adjusted gross income exceeds $100,000 if married filing jointly. Both John Q and his wife each earned over $ 100,000—and the $25,000 allowable for rental losses completely phases out at $150,000.
LOSS IS DEDUCTIBLE IN YEAR OF TOTAL DISPOSITION
Finally the kids graduate from college and now Joe Q can take the disallowed losses if he makes a complete disposition of the property, so he puts it up for sale and finally sells it..
In the year of the sale he actually, finally, has a small profit, but those prior disallowed losses can be taken which gives J.Q. a good sized deduction. He can subtract the big prior loss from the current year gain, leaving a good-sized loss for the year.
DEPRECIATION RECAPTURE RULE
There is just one more thing to complicate matters. When he sells the property his loss is increased by the depreciation he took. This increases his capital loss, but the depreciation is recaptured and is treated as ordinary income rather than a capital gain or loss. If J.Q. had made a gain on the sale, the gain would be reduced by the “recapturing” the depreciation—which, in plain English, means that it would be taxed as ordinary income and not at the lower capital gains rate. If there were a gain over-and-above the recaptured depreciation, it would be taxed at the capital gains rate. On the one hand you finally get to take the deduction in calculating the gain, if any, but the capital gain is transformed, in part, into ordinary income. (The total gain would be the same, but it is split into ordinary income and capital gain.)
HOW TO REPORT GAINS OR LOSSES ON SALE OF A RENT HOUSE.
The net results end up on Page 1 of Form 1040—Line 14 for the Gain or loss on the sale, Line 17 for the rental income or loss, Schedule E for gross rents and Rental Expenses, Form 4797 to report Sales price, Depreciation Allowed, Cost/Basis of the Property and Gain or loss on the sale. You may also need to fill out Form 8582, Passive Activity Loss Limitations. If you are using Tax Software, you may be asked what IRS code section applies to the sale. In the case of the sale of a Rent House, it would be Section 1250.
Unless you are a tax professional, you probably should not try to do this kind of tax return yourself.
-SOMETIMES YOU NEED A PIG FOR A PAL-
If J.Q. had also had other Passive Activities which generated gains, he could have offset those delayed deductions against the passive gains—so it pays to have a PIG for a PAL; that is, a Passive Income Generator for a Passive Activity Loss.
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This information is not intended to be advice to the recipient. In compliance with Treasury Department Circular 230, unless stated to the contrary, any Federal Tax advice contained in this Blog was not intended or written to be used and cannot be used for the purposes of avoiding penalties.