Sale of a new house

[Anonymous]

I demolished a fully depreciated rental unit and built and sold a new house. How do I report this?

[M-MTax]

No recapture or gain on the demolished building because you got nothing for it. Add the demo costs to the purchase price or construction costs of your new house and that's your basis. If the new house is a rental you have recapture on that. 

[Hal_Al]

It may be best explained by example.  You bought the original house and lot for $50,000. Depreciated $25,000. You spent $100,000 demolishing the old house and building the new one. You sold it for $200,000.

Your cost basis is $100,000 + $50,000 - $25,000 = $125,000.  You have a capital gain of $75,000 ($200,000 - $125,000 = $75,000), of which $25,000 is depreciation recapture (section 1250 gain). 

In TurboTax (TT), I think it goes smoother if you report it as the sale of a business asset (Business items section of income), rather than reporting it in the rental income section.  You enter $150,000 cost basis and $25,000 depreciation claimed. 

Edited per martinmarks comment

ALTERNATE METHOD

The depreciation recapture can be avoided.  Here's a revised example. Although the net capital gain calculation is the same ($75K), depreciation recapture (which is taxed at a higher rate than long term capital gains) is avoided.

You bought the original house and lot for $50,000 and broke down the cost as $25,000 for land and $25,000 for building. You fully depreciated the building $25,000. You spent $100,000 demolishing the old house and building the new one. You sold it for $200,000.

Your report the disposal of the original building as a sale for $0. $0 sale amount -$25K cost basis + $25k depreciation recapture = $0 capital gain.

Your cost basis for the new building is $100,000 + $25,000 for land = $125,000.  You have a capital gain of $75,000 ($200,000 - $125,000 = $75,000).

In TurboTax (TT), I think it goes smoother if you report it as the sales of  business assets (Business items section of income), rather than reporting it in the rental income section.  You enter the disposal of the original building as a separate asset (property) sale from the new building with land.

[M-MTax]

Nope, NO RECAPTURE of depreciation taken on the demolished house!

The house was demolished so it's value was $0.....it was not sold or disposed of.....it was demolished. 

This isn't any different than if you bought a computer for your business and threw it away after it was fully depreciated.....basis is $0 but so is what you got for it which is also $0.

[Carl]

While the explanations given are correct, they don't tell you how to deal with it in the TurboTax program. In order to give you those details, we need to know the following.

1) Was the last occupant to vacate the old house a paying tenant?

2) If yes to 1), when did they move out?

3) When was the structure demolished?

4) When was construction of the new structure completed?

5) What is the status of the new structure? Is it a rental? Did you sell it? Did you move into it as your primary residence? When?

[M-MTax]

While the explanations given are correct

The explanation by HalAl is NOT correct.

The example says depreciation needs to be recaptured on the house that was demolished and that's wrong. The demolished house is worth $0 after demolition...it was not sold or disposed of so the owner got $0 for it AND the depreciation deductions DON'T get added to the newly built house. 

There is no recapture of the depreciation taken on the demolished house.

[Hal_Al]

I think @M-MTax  is correct. The depreciation recapture can be avoided.  Here's a new example. Although the net capital gain calculation is the same ($75K), depreciation recapture is taxed at a higher rate than long term capital gains.

It may be best explained by example.  You bought the original house and lot for $50,000 and broke down the cost as $25,000 for land and $25,000 for building. You fully depreciated the building $25,000. You spent $100,000 demolishing the old house and building the new one. You sold it for $200,000.

Your report the disposal of the original building as a sale for $0. $0 sale amount -$25K cost basis + $25k depreciation recapture = $0 capital gain.

Your cost basis for the new building is $100,000 + $25,000 for land = $125,000.  You have a capital gain of $75,000 ($200,000 - $125,000 = $75,000).

In TurboTax (TT), I think it goes smoother if you report it as the sales of  business assets (Business items section of income), rather than reporting it in the rental income section.  You enter the disposal of the original building as a separate asset (property) sale from the new building with land.

[Anonymous]

Hi Carl,

Thanks for the questions.

1&2)  The last person to occupy the old house was a paying tenant.  They moved out in December 2018.  The property has been out of service since then, with no depreciation taken or income received.

3)  The structure was demolished in August 2019.

4)  Construction was completed in February 2021.

5)  The new structure was sold in March.  No one lived in the property between completion and sales.

[M-MTax]

Construction was completed in February 2021.

5)  The new structure was sold in March.  No one lived in the property between completion and sales.

Looks like you never rented the new structure so no depreciation to deal with and since no one lived there it would be an investment property. Anyway, you know your basis......see HalAl's message......and your sales price so you should be able to figure your gain.

[Carl]

So you'll just show the old property as completely converted to personal use effective the date the tenant moved out. I expect you did that on your 2018 tax return. 

For your 2019 tax return and on, that property should not even be shown on SCH E at all.

For your 2021 tax return you'll report the sale in the Investments section.

Your cost basis on the new structure is figured as follows:

For starters, the cost basis of the land usually doesn't change. But it does/can change if there's any depreciation not yet taken.

Add  any remaining depreciation not yet taken to the cost of the land. As I understand it, the property was fully depreciated. If so, your cost of land will remain unchanged.

Add your demolition costs to the cost of the new structure, if not already included in the invoicing from the construction contractor.

Since the property was sold within one year after work was completed, I do not know for a fact if the sale results in a short term gain which is taxed at a higher rate, or a long term gain because you owned "the property" so to speak, for more than a year. If I were to guess, (I haven't looked at the IRS pubs on this) I would expect any Section 1250 gain to be treated short term.

[M-MTax]

Add your demolition costs to the cost of the new structure

No.....add the demolition costs to the cost of the land BUT it may not matter much.

I would expect any Section 1250 gain to be treated short term

There's no "Section 1250 gain"....or maybe you meant unrecaptured Sec 1250 gain but there's none of that either. 

[Carl]

@M-MTax thanks for clarifying on that. I really wasn't that sure about the 1250 stuff.

[M-MTax]

No problem BUT I'm still foggy on the LT ST stuff because the land is LT.....no doubt about that......but the structure may be allocated LT/ST depending on intended use and other factors.

[Carl]

but the structure may be allocated LT/ST depending on intended use and other factors.

That's where my lack of clarity is. I've not yet taken the time to read through any of the IRS pubs to see if there's anything that would apply to this situation either.

[M-MTax]

That's where my lack of clarity is. I've not yet taken the time to read through any of the IRS pubs to see if there's anything that would apply to this situation either.

Don't think there is. Most of the stuff involves developers and rental properties.