I sold a rental property for a profit this year, and I want to make sure that I understand the tax implications. I paid $52,789 for the property and sold it for $161,000. I understand that I will have to pay capital gains tax on the taxable gain of the adjusted cost basis and the selling price, less repairs, business expenses, and the real estate broker commissions, etc. The depreciation on the property was $40,448.93 over the years I owned it. Also, I have about $44,000 in increased cost basis due to additions, remodeling, siding, etc., with approximately $15,000 in depreciation capture that l have to claim for these additions, remodels, and siding, etc. If I am understanding correctly, I will have to pay 25 percent recapture tax (Section 1250 capital gain at a rate of 25 percent) on the $76,448.93 recaptured depreciation from both the property and additions/remodeling. Please let me know if I am correct.
The big question I have is on appliances. I purchased appliances over the years in this rental property. I know I will have to recapture that depreciation also (probably as a group, as the rental and appliances were sold together and all appliances were fully depreciated). But I had to replace two appliances twice over the years—a stove and a refrigerator (each twice). Do I recapture the depreciation twice for the refrigerator and twice for the stove, or do I only recapture the depreciation for last time I replaced the stove and refrigerator?
To calculate the total gain realized on the sale of your rental property, the first step is to subtract your adjusted cost basis from the amount you realized on the sale.
Your amount realized in this case would be the amount of cash proceeds you received, less any closing costs and any expenses incurred to ready the property for sale. The amount realized (the net sale proceeds) should be allocated between land, building, and any other rental property furniture and appliances in calculating the gain. Because the furniture and appliances are fully depreciated, it would be a reasonable position to not allocate any net sale proceeds to these items.
The adjusted cost basis would be your initial cost basis (generally, the amount paid for the property plus certain settlement costs), plus the cost basis of your additions, less the cumulative amount of depreciation taken on each type of property up to the date of sale.
Once the amount of gain has been determined for the land and building (assuming no gain on the furniture and appliances), you can then determine the character of the gain.
First, the gain related to the sale of the land is capital gain in nature (taxed at a rate of 15 percent or 20 percent, depending upon your personal income tax situation) under Internal Revenue Code Section 1231, because it is the sale of an asset used in a trade or business.
Next, the gain related to the sale of the building is also capital gain. Some of this Section 1231 gain, however, will be characterized as Unrecaptured Section 1250 gain (taxed at a rate of 25 percent) to the extent of depreciation claimed on the building.
Lastly, because it is assumed that there will not be any gain realized from the sale of the furniture and appliances, there will be no ordinary income recapture under Section 1245 for any of the depreciation claimed on the furniture and appliances.
It is important that you keep appropriate and complete records to substantiate your calculations of reportable gain. A CPA can provide more detailed advice to help you obtain the best tax result from the sale of your rental property.
For more resources, check out PICPA’s Money & Life Tips, Ask a CPA, or CPA Locator.
Answered by: James G. McGrory, CPA, and Stephanie K. Otake, CPA, are with Drucker & Scaccetti in Philadelphia.