Calculate depreciation and capital gain for surviving spouse

[hmlow]

Would greatly appreciate hearing if I have a correct picture view on how the capital gain and depreciation is handled for rental property when sold by the surviving spouse. 

My parents bought a rental property back in 1970.  Father passed away in 1989.  Mother wants to sell it in 2022.  Say back in 1970, they paid 50,000.  In 1989 FMV was 100,000.  Current market value is 300,000.  These prices include the value of Land and after subtracting that, the price of the structure are 40,000, 80,000, and 240,000, respectively.

They held title as joint tenancy and therefore in 1989, only the basis of my father’s half is stepped up.  So half of the original price (includes land), ie. 25000, is stepped up to 50000.  Mother’s basis from date father passed away in 1989 is 50,000 plus 25,000 or a total of 75,000 and the basis for land is 15,000 (If title was held as community property with rights of survivorship, the step up would have been to the 1989 FMV of 100,000).

The structure, but not land, is to be depreciated for the next 27.5 years.  From date of passing, it is 75,000 minus 15,000 or 60,000.  All previous depreciation amounts are irrelevant.

Now in 2022, a sale of the rental property at 300,000 is completed.  Depreciation of 60,000 for the structure has been fully taken.  Say another 10,000 of depreciation for carpet replacements were fully taken since 1989.  So a total of 70,000 is subject to recapture taxes.

For calculate the capital gain to be taxed, the selling price of 300,000 less the stepped up basis of 75,000 and less selling fees of say 20,000 equals 205,000.

Lastly, estimated taxes should be paid!

Thank you for any feedback!

[ColeenD3]

Yes, it all sounds about right. I did not follow the actual math but the theory sounds correct. My only question was that you said, "All previous depreciation amounts are irrelevant." What did you mean by that?

[hmlow]

Thanks for questioning this as it raises a very important topic- depreciation recapture taxes. 

What was meant by "All previous depreciation amounts are irrelevant" was the amounts counted as depreciation for the tax years between 1970 to the date of father passing in 1989 isn't counted for depreciation recapture taxes.  Is it correct that the 19 years of depreciation is not to be counted?

And so is it correct that depreciation starts all over for the next 27.5 years using the 1989 FMV of the property (less the FMV of the land since only the structure can be depreciated)?   With the numbers used, this is 60,000 of depreciation taken from 1989 to 2016.  By selling in 2022, the 60,000 is counted for depreciation recapture taxes (in the story, it totaled 70,000 since there was 10,000 more in depreciation taken for carpeting).

The next step is how to input this in TT correctly so that my conceptual understanding of all this is reflected with the appropriate numbers in the the correct tax forms.  But I think that's best discussed in a new thread!

Again, thanks for any feedback and educating me on how this is suppose to be done!

[Anonymous_]

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@hmlow wrote:

(If title was held as community property with rights of survivorship, the step up would have been to the 1989 FMV of 100,000).

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If title had been held as community property that is located in a community property state, then the property would receive a full (100%) step up in basis. Otherwise, only the half acquired from the decedent by the surviving joint tenant would receive a step up in basis.

[Anonymous_]

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@hmlow wrote:

Lastly, estimated taxes should be paid!

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You simply want to avoid an underpayment penalty, which can be done as follows:

You may avoid the Underpayment of Estimated Tax by Individuals Penalty if:

• Your filed tax return shows you owe less than $1,000 or
• You paid at least 90% of the tax shown on the return for the taxable year or 100% of the tax shown on the return for the prior year, whichever amount is less.

[Anonymous_]

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@hmlow wrote:

...is it correct that depreciation starts all over for the next 27.5 years using the 1989 FMV of the property...

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Yes, with respect to the one-half that was acquired by the surviving joint tenant.