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I'd like to buy the interest in a small pship that holds 1 propert. Purchase price was 400k. Current value 675k, loan of 270K on property. What is approx value of pship

Owners haven't taken depreciation and have rented it a break even for 3 years.
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I'd like to buy the interest in a small pship that holds 1 propert. Purchase price was 400k. Current value 675k, loan of 270K on property. What is approx value of pship


@Jeff D2 wrote:
Owners haven't taken depreciation and have rented it a break even for 3 years.

That, itself, presents a huge issue. Depreciation on rental property is taken (deducted) each and every year until the entire basis (typically the purchase price allocated to the depreciable property) is recovered.

 

The equity appears to be $405,000 but there are other variables. 

 

As a result, you need an in-person consultation with an attorney or financial advisor (preferably both) who can evaluate the investment.

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11 Replies

I'd like to buy the interest in a small pship that holds 1 propert. Purchase price was 400k. Current value 675k, loan of 270K on property. What is approx value of pship


@Jeff D2 wrote:
Owners haven't taken depreciation and have rented it a break even for 3 years.

That, itself, presents a huge issue. Depreciation on rental property is taken (deducted) each and every year until the entire basis (typically the purchase price allocated to the depreciable property) is recovered.

 

The equity appears to be $405,000 but there are other variables. 

 

As a result, you need an in-person consultation with an attorney or financial advisor (preferably both) who can evaluate the investment.

I'd like to buy the interest in a small pship that holds 1 propert. Purchase price was 400k. Current value 675k, loan of 270K on property. What is approx value of pship

I agree with @tagteam see a financial advisor and tax pro. failure to take depreciation is a huge red flag.  there may be other issues such as have they filed partnership returns.  =other than depreciation does its method of accounting comply with the tax laws. with depreciation, there would be losses and these would be passive which means you might not get any tax benefit until the property is sold. 

 

Carl
Level 15

I'd like to buy the interest in a small pship that holds 1 propert. Purchase price was 400k. Current value 675k, loan of 270K on property. What is approx value of pship

have rented it a break even for 3 years.

I seriously doubt that. Especially with a mortgage on the property.  But the depreciation issue is a big one. Were I in your shoes on this one, I would have walked away from it yesterday.

I'd like to buy the interest in a small pship that holds 1 propert. Purchase price was 400k. Current value 675k, loan of 270K on property. What is approx value of pship


@Carl wrote:

have rented it a break even for 3 years.

I seriously doubt that. Especially with a mortgage on the property.


Except in this case the mortgage and the foregone depreciation deductions come close to cancelling each other out. Actually, the mortgage payment is probably less than the depreciation deduction. 

I'd like to buy the interest in a small pship that holds 1 propert. Purchase price was 400k. Current value 675k, loan of 270K on property. What is approx value of pship

Unfortunately, many taxpayers miscalculate what "breaking even" means for tax purposes.  It is not the property's cash flow, as one cannot deduct the mortgage principal payments,

I'd like to buy the interest in a small pship that holds 1 propert. Purchase price was 400k. Current value 675k, loan of 270K on property. What is approx value of pship

That is true and, further, many miscalculate with respect to depreciation deductions since it is an expense for tax purposes but a phantom expense as a result of not requiring an actual payment. 

I'd like to buy the interest in a small pship that holds 1 propert. Purchase price was 400k. Current value 675k, loan of 270K on property. What is approx value of pship

Thank you all.  By break even I was referring to cashflow, not profit/loss for tax purposes.  The partners are in the process of filing and amending tax returns, and everything will be caught up depreciation wise as of 12/31/2021.  I guess what I'd like to know is if the depreciation would have any effect on the value of the partnership interest of one of the partners.   I would be buying the interest of one of the 2 partners if I was to go forward with this.  Thanks! 

Carl
Level 15

I'd like to buy the interest in a small pship that holds 1 propert. Purchase price was 400k. Current value 675k, loan of 270K on property. What is approx value of pship

I know this will all sound "negative". But it is things one needs to take into consideration, along with the good and potential good.

By break even I was referring to cashflow, not profit/loss for tax purposes.

Glad you clarified. Keep in mind that with a mortgage, the principle part of each payment is not deductible. Only the interest. Generally, taxation of that principle is offset by the depreciation you're required to take. What some don't realize though, is that depreciation is not a permanent deduction. When the property is sold, depreciation is recaptured and taxed in the tax year of the sale. One things I think it's important to know about the depreciation recapture though.

 While recaptured depreciation itself will be taxed anywhere from 0% up to a maximum of 25%, recaptured depreciation is also added to your AGI. So one must look at the potential that the increased AGI caused by the recapture may bump you into the next higher tax bracket. Not a big deal really, if it only bumps you from the 10% to the 12 % bracket. But depending on the amount of the increase, the jump from the 12% to the 22% bracket could leave you somewhat surprised.

The partners are in the process of filing and amending tax returns, and everything will be caught up depreciation wise as of 12/31/2021.

Hopefully, they're doing it correctly. When you haven't taken depreciation for 2 or more consecutive years, one can't just amend to catch up. It's considered a change in accounting method and one has to file a form 3115 with the most current tax return in order to change from what is an impermissible accounting method (not depreciating) to the permissible and correct method.  So if you're not doing so already, you should confer with a tax professional of your choosing, on their most current tax return (which will be the 2021 form 1065 partnership return) to ensure things are fixed here, and are in your best interest.

I guess what I'd like to know is if the depreciation would have any effect on the value of the partnership interest of one of the partners.

One key thing here is not just asking questions, but knowing what questions to ask. I have questions that I can't answer. But a tax professional can.

 - When I buy in to a partnership by buying out an existing partner, do I also buy their share of the existing depreciation taken? The answer to that question matters, because when the partnership sells the property I would "think" (I don't know for a fact) that my share of recaptured depreciation will increase my AGI.

 - Does the cost basis change when I buy in to the partnership, meaning that "my" share of required depreciation starts on my buy-in date?

Those are two questions I have, but can't answer myself.

I would be buying the interest of one of the 2 partners if I was to go forward with this. Thanks!

I'd like to buy the interest in a small pship that holds 1 propert. Purchase price was 400k. Current value 675k, loan of 270K on property. What is approx value of pship


@Carl wrote:

 - Does the cost basis change when I buy in to the partnership, meaning that "my" share of required depreciation starts on my buy-in date?

Those are two questions I have, but can't answer myself.


With partnerships, there is an inside basis and and an outside basis.

 

@Rick19744 would be invaluable here since he is essentially an expert in this area of tax law.

I'd like to buy the interest in a small pship that holds 1 propert. Purchase price was 400k. Current value 675k, loan of 270K on property. What is approx value of pship

While you may be interested in acquiring an interest in a "small" partnership, unfortunately the partnership tax world rules apply to all partnerships regardless of size and get complicated very quickly.

A few comments:

  • I agree with other comments in that you would be best served having a one on one with a tax professional who understands the partnership tax world; not all do.
  • Your question on approx value.  This is best determined by an appraisal of the property by a real estate professional.  This figure may come close to your stated value or it may not.  But it is in your best interest to understand what a true FMV is.
  • The FMV comes into play for you, as your purchase price (FMV) less the adjusted basis of your purchased interest is important.  There is a difference between your purchase price (outside basis) and the adjusted cost basis (inside basis).  This difference would allow the partnership to make a Section 754 step-up election and then have a Section 743(b) adjustment allocated to you specifically.  This is essentially a depreciation adjustment allocated to you since you are paying FMV for your portion.
  • Just in round and unverified figures, this step-up to you could be in the vicinity of $160,000 if you were acquiring a 50% interest.
  • The rules for depreciation are an "allowed or allowable" provision.  This means the basis of the property is reduced whether depreciation is taken or not.  Based on the limited facts, this amount could be in the vicinity of $29,700 to $43,000 depending on the month it was placed in service and assuming 3 years of missed depreciation.
  • The depreciation issue can be fixed, but a fix would require a Form 3115 and then a Section 481(a) adjustment for the depreciation that was not taken.  This Section 481(a) adjustment is then allocated to the partners.  Since one of the partners is being bought out, the purchase price should be adjusted for the Section 481(a) adjustment that this partner would miss out on.  I guess the partner's portion of this Section 481(a) adjustment could be allocated to them in the year of sale and not require a purchase price adjustment.
  • There are other issues that would need to be addressed as a result of selling the partnership interest depending on whether there were any "hot assets" held.  There would be a required form to include with the Form 1065 and the selling partner would need certain information to properly determine the character of their gain.
  • The debt could be an issue if the selling partner used any debt to take tax losses.
  • As you can see, this is not necessarily for the feint of heart and best to get some professional help in the year of sale and to fix the depreciation issue. 
*A reminder that posts in a forum such as this do not constitute tax advice.
Also keep in mind the date of replies, as tax law changes.
Carl
Level 15

I'd like to buy the interest in a small pship that holds 1 propert. Purchase price was 400k. Current value 675k, loan of 270K on property. What is approx value of pship

Thanks for jumping in here Rick. I myself could only somewhat "speculate" based only on my personal experience with rentals on SCH E on a personal return, and not in a partnership. I can see that this particular situation is a mess, because I'm finding it a challenge to comprehend all the information you provided. 🙂

 

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