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bchenoweth
Level 2

Capital gains on sale of rental property

I am looking for help on a situation that I am confused with when calculating capital gains tax.  What I am not sure of is what should be used for the cost basis of the property. I lived in the home and converted it to a rental however I did NOT live there for 2 of the last 5 years it has been rented out the last 8 years.  

 

When speaking to a local tax accountant they said I have to use the FMV of the house at the time it was converted to a rental.  This does not seem right to me since I bought the home for 186000 and at the time i converted it to a rental I owed around 160,000 on the property.  Due to the market crash back many years ago at the time I converted it to a rental the FMV was 105,000.

 

It is my understanding from what I am reading online that FMV should only be used when claiming a loss on the property.  For my situation I sold the home for $200,000 do I really need to claim 95,000 in capital gains for a home I did not gain 95,000 from?

 

Keep in mind these are rough numbers as I know there are things that need to be added in like repayment of depreciation and sales costs and things like that but for the starting number do I need to use the FMV at the conversion time or the purchase price of the home?

1 Best answer

Accepted Solutions
tagteam
Level 15

Capital gains on sale of rental property

In that event, your basis for computing a gain is the original cost (or other basis) plus the cost of improvements made, if any, less accumulated depreciation.

View solution in original post

13 Replies
tagteam
Level 15

Capital gains on sale of rental property


@bchenoweth wrote:

It is my understanding from what I am reading online that FMV should only be used when claiming a loss on the property.  


Per Treas. Reg. §1.165-9(b)(2), you would use the lesser of the fair market value on the date of conversion or the adjusted basis on the date of conversion for the purposes of determining a loss.

bchenoweth
Level 2

Capital gains on sale of rental property

Treas. Reg. §1.165-9(b)(2) pertains to claiming a loss on a rental property sale.  I am not claiming a loss it is a gain.

 

Bryan

tagteam
Level 15

Capital gains on sale of rental property

In that event, your basis for computing a gain is the original cost (or other basis) plus the cost of improvements made, if any, less accumulated depreciation.

View solution in original post

bchenoweth
Level 2

Capital gains on sale of rental property

Do you know the specific part of the tax code that shows this so I can prove this is the correct way to do it.  The person who does my taxes is not convinced.

 

Bryan

tagteam
Level 15

Capital gains on sale of rental property


@bchenoweth wrote:

Do you know the specific part of the tax code that shows this so I can prove this is the correct way to do it. 


If there is a gain, then you would apply the general basis rules in Section 1011 et seq.

bchenoweth
Level 2

Capital gains on sale of rental property

This is the response I got back from our accountant when telling her that we shouldn't use FMV at time of rental conversion.  Do you have any thoughts on her response below?

 

OK here are your options:

 

You have to use the FMV at the dates of conversion of the rental, what we had was the 112,000 if this wasn’t the case we need the documentation to catch it up but will also have to recalc depreciation as well.   Typically whatever we put on when we start the rental so if this was incorrect we need to do a 3115 a change in accounting method and do the catch up. 

 

Converting to rental;

Basis of Property Changed to Rental Use

When you change property you held for personal use to rental use (for example, you rent your former home), the basis for depreciation will be the lesser of fair market value or adjusted basis on the date of conversion.

As stated above this is what would be used for the basis.

tagteam
Level 15

Capital gains on sale of rental property


@bchenoweth wrote:

This is the response I got back from our accountant when telling her that we shouldn't use FMV at time of rental conversion.  Do you have any thoughts on her response below?


Yes, I have one thought: Your accountant is conflating the basis used for depreciation after converting property held for personal use to rental use with the basis used for a sale of the rental. The two bases can be different and the calculation of the basis of rental property sold at a gain, except in inheritance and like circumstances, is the adjusted basis plus improvements less depreciation allowed or allowable.

 

There is a rationale for the determination of basis depending upon the nature of the calculation. The rationale for using the lesser of FMV (when placed in service) or adjusted basis for the purposes of depreciation is so an owner of rental property that has devalued cannot take whopping depreciation deductions based upon a much higher purchase price (or whopping deductions based upon appreciation while the property was held for personal use).

 

tagteam
Level 15

Capital gains on sale of rental property

@bchenoweth Also, ask your accountant if she has any authority for her position that the basis for the sale of your rental property at a gain is the lesser of FMV or adjusted basis on the date of conversion.

 

I already provided authority for sales at a loss and at a gain in one of my previous answers. 

Anonymous
Not applicable

Capital gains on sale of rental property

I would say you need a new tax preparer. since she is incorrect on this issue, who knows what other things she might have messed up on your return.  

Critter-3
Level 15

Capital gains on sale of rental property

Old adage for the basis when selling ...   if the cost basis for a loss ends up being a gain and the cost basis for a gain ends up being a loss then  you have no gain or loss. https://www.marketwatch.com/story/how-to-handle-tricky-tax-rules-when-you-convert-your-house-into-a-...

 

So if your cost basis (purchase price) was say 150K (basis for a gain)  and  the FMV for depreciation was 100K (basis for a loss) then  if you sell it for  anything between 100 - 150 you have no gain or loss.  Sell for less than 100 you have a loss or sell for more than 150 you have a gain.  Of course this is a simplified example ... in your case the depreciation taken and recaptured will have to come into play first.

bchenoweth
Level 2

Capital gains on sale of rental property

I agree I'm going to have to find a new tax preparer in the Minnesota area.  If someone on here knows any good ones that understand this situation please let me know.

AmeliesUncle
Level 12

Capital gains on sale of rental property

The easy-to-read version is on page 11 of Publication 551 (but things are more complicated in situations where there is NEITHER a gain or a loss):

 

 

Sale of property.

 

If you later sell or dispose of property changed to business or rental use, the basis of the property you use will depend on whether you're figuring gain or loss.

Gain. 

The basis for figuring a gain is your adjusted basis when you sell the property.

Example. 

Assume the same facts as in the previous example except that you sell the property at a gain after being allowed depreciation deductions of $37,500. Your adjusted basis for figuring gain is $165,500 ($178,000 + $25,000 (land) − $37,500).

Loss. 

Figure the basis for a loss starting with the smaller of your adjusted basis or the FMV of the property at the time of the change to business or rental use. Then adjust this amount for the period after the change in the property's use, as discussed earlier under Adjusted Basis , to arrive at a basis for loss.

Example. 

Assume the same facts as in the previous example, except that you sell the property at a loss after being allowed depreciation deductions of $37,500. In this case, you would start with the FMV on the date of the change to rental use ($180,000) because it's less than the adjusted basis of $203,000 ($178,000 + $25,000) on that date. Reduce that amount ($180,000) by the depreciation deductions to arrive at a basis for loss of $142,500 ($180,000 − $37,500).

 

https://www.irs.gov/pub/irs-pdf/p551.pdf#page=11

Critter-3
Level 15

Capital gains on sale of rental property

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