how to determine the price of my improvement such as tile floor when I sale my rental house

[Darasc0211]

I purchased my rental house in 2015 and I made lots of improvement throughout the years (ex; tile floors, landscaping, appliances and etc). The house has been rented after the purchase and was sold in 2020. I know I need to recapture the deductions taken for these improvement, but I have the following questions:1)How to determine the sale price of each improvement (floors, landscaping, appliances and etc) since they were sold along with the house and all I know is the sale price of the house? 2) Shall I deduct whatever sale price estimated for the investment from the sale price of the house? 3) Is it appropriate just to enter $1 in Turbotax  for each investment since the house sale price already covers all the investment?(I mention $1 as I read from other thread that Turbotax will not fill the recapture info if I fill 0). I appreciate your help!

[Mike9241]

did you expense these items or treat them as assets and thus depreciate them over their lives.

if you expensed them there is no sales price to allocate. if you treated them as assets since it's doubtful they themselves would be worth more than their depreciated value, I would allocate just enough in sales proceeds so there is no gain or loss. 

there is no rule or formula for determining the allocation of the sales price. if you so desire, you could pay for an appraiser to give you the FMV of each asset you capitalized.  it would likely be costly and I don't really advise this. 

[Carl]

There is no hard fast rule about allocating your sales price across assets. but there are some quirks in the TTX program that make it necessary to sort of self-impose a few rules.

First, as I'm sure you're aware, when selling the property you have to allocate your sales price between the land which is not depreciated, and the structure which is depreciated. If you have other assets listed which would occur if you did any property improvements over the years you owned it, most likely all of those property improvements are assets that you've taken depreciation on.

So what you need to do is allocate your structure sales price across all other depreciated assets. You will not allocate the land sales price across depreciated assets, since the land is not depreciated and was never depreciated.

When allocating your sales price across depreciated assets it's important to allocate in such a way so that if you sold the property at a gain, you show a gain on all assets. It doesn't matter if that gain is $1 on some assets, and $10,000 on other assets. A gain is a gain.

Likewise, if you sold the property at a loss, then you should allocate your sales price so that you show a loss on all assets. Even if that loss is only $1 on some assets. A loss is a loss.

So if you sold the property at a gain (I am assuming you did) then your sales price on each asset should be at least $1 more than it's original cost basis. That way, all depreciation is correctly recaptured by the program. If you show a gain on some assets and a loss on others, that screws up the depreciation recapture and the form 4797. Unfortunately, the program will not catch that error and flag it. But it's still an error that, depending on your AGI, could raise flags while being processed by the IRS.

Take note that if you did not depreciate your property improvements, then in the year of sale you are still required to recapture the depreciation you should have taken, and pay taxes on it.

[Darasc0211]

Mike and Carl:

Thanks for your prompt reply. I did listed all the improvement as assets and sold my rental house at a gain. I have additional questions:

1) How do I fill the sale price of the rental house in Turbotax? Should I use the property sale price in 1099S (350k) subtract the sale price of all the assets such as improvement on tile floor etc (50K), and also  substract the land (70k)? By this calculation the sale price of the property is 350k-50k-70k=230k, which is much lower than what's shown in 1099S. Is it correct?

2) The closing cost is the sale expense for the sale of the property and all other assets as a whole, so how to fill the "sale expenses (business portion only)" for each asset?

I appreciate your help!

[Carl]

1) I don't recommend you use the amount on the 1099-S at all. This is because in my past experience over the years, issuers of that form can't seem to make up their minds. It may show the actual cash that was put in your hand at the closing, or it may show the "real" gain on the sale after expenses, or it may or may not include the existing mortgage payoff amount. So your sales price is the price you contracted to sell it at. Your taxable gain if any, will be any gain realized after subtracting your cost basis and any sales expenses, then adding any recaptured depreciation to that.

2. As the seller, you don't have any sales expenses associated with acquisition of the property. It's common for the  buyer to pay those expenses. You may have expenses associated with disposition of your mortgage on the property, as disposition of the property itself. For example, if you paid commissions to a realtor, that's a sales expense. Typically, commissions are the biggest sales expense and in some cases may be the only sales expense of the seller. But you have to look at your copy of the closing statement to see if you have any other expenses you paid as the seller, with the amount shown in the "Paid from seller's funds at settlement" column on the HUD-1 closing statement.

Other expenses you could have but would not be common for the seller, would be a portion of property taxes that may be due. But it's more common for the buyer to re-reimburse the seller a pro-rated amount of the property taxes the seller paid at some point in time within the last 12 months of the closing.The reimbursed amount of property taxes actually gets added to your gain.

[Darasc0211]

Hi, Carl:

Thanks for your response. I am trying to allocate the sale price of each asset and here is my proposal. The sale price of my  rental property is $359900, which is 359900/255000=1.4 times of the purchase price ($255000) of the rental property. The sale price of each asset should also be 1.4 times of the purchase price of each asset. For ex: if the purchase price of my AC is $5000, the sale price of the AC is $5000x1.4= $7000. Does it make sense? Thanks.

[Carl]

You can most certainly do it that way if you want. Maybe it makes the math easier for you? Now while $255,000 may be your purchase price, is that your cost basis? Remember, cost basis includes your purchase price when you originally acquired the property, plus the cost of any improvements you paid for during the time you owned it. Does that purchase price also include the cost of any and all property improvements you paid for since you purchased it? If not, then your cost basis would actually be higher. If it does include the cost of property improvements, then your math is fine.

But generally, since you sold at a gain, so long as the sale price of each asset is "at least" $1 over it's cost basis, you'll be fine; as that will allow for the program to correctly recapture depreciation taken on all assets.  Example:

Back in 2015 you purchased a new central air system at a cost of $10,000. Since that becomes "a material part of" the property, it gets classified as residential rental real estate and depreciated over 27.5 years. On the closing date of the sale you had taken approximately $2000 of depreciation on that asset. The adjusted cost basis would then be $8,000. If you report a sale price of $$9,000 "on paper", then there would only be $1000 of depreciation recaptured, and the other $1000 would be a loss on that one asset. That's wrong since you sold the property at a gain.

Whereas if you report a sales price of $10,001, you'd have the full $2000 of depreciation already taken recaptured and taxed correctly with an additional $1 gain on the sale of that specific asset.

Correct depreciation recapture really comes into play in a much more important way if your AGI will put you above the 24% tax bracket. Sometimes the sale of real estate will do exactly that. Since the maximum tax rate on recaptured depreciation is 25%, if your AGI bumps you from the 24% bracket into the 32% tax bracket, having that recaptured depreciation capped at 25% can really make a difference that you'll notice.