Unexpectedly high capital gains taxes on rental home sale

[dclive]

I have a rental home that I bought in 2002 for $250k (land value, perhaps $81k at the time?, improvement value of the rest - $169k), I lived in it for 8 years or so, then I put it up for rent on 1.1.2010, and it's been rented since.  In late 2021 the renter left the property, and on 1.6.2022 I sold the property for about $342k (after deduction of HUD1 costs like realtor commission, etc. - but not deducting for $3700 in staging furniture fees or $650 in cleaning fees or $350 in inspection / engineering report fees, which were all required to sell the house). 

In the years I had the rental property, I used MACRS depreciation, 27.5 year recovery, $6139/year, for the depreciation allowance, for a total 'prior depreciation' of 73412, according to TT22.  (One notes that

73412 divided by 6139 is 11.95, and there are 12 years from 2010 to 2022....) 

After plugging in my numbers into TT22-P, I'm told that I have the following: 

Asset Sales Price 271511

Asset Expense of Sale 34175 [$3700, $350, $650 added here] 

Land sale price 105389

Land expense of sale  9601

That part looks fine; sum of the 2 sales prices are the grand total of what I sold the home for, and minus the expenses (and with $3700+650+350 in extra added expense) that's what I actually walked away with at closing, via a check to me. 

The point of my confusion:  TT says I have a gain on this of $142179, and a land gain of 14613, for a total long term gain of $156,792. 

1.  Where does it get this?  I'm looking at my form Asset Entry Worksheet and it's not completely clear to me why these values were chosen.  If my home goes from $250k in 2010 to $345k-ish in 2022, isn't that 95k in gains, total, spread across land and improvement, minus the extra $3700, $350, $650 in other expenses?

2.  I thought capital gains was taxed at 15%.  Yet before the house sale is figured in, I'm owed $3k or so by the IRS.  Once I add the house sale, I owe the IRS around $30k; that's essentially $33k in extra taxes, or about 1/3 of the $95k I see as my long term capital gain.  I don't understand this math...

Any thoughts or help available? 

[Anonymous_]

You may have a basis issue since it appears you converted your residence to rental use. As a result, you should have used the lesser of your adjusted basis or the fair market value of the property as your basis for depreciation.

That aside, however, you might want to enter Forms Mode and review your Unrecaptured Section 1250 Gain Worksheet, your Schedule D Tax Worksheet, and your Schedule D. You should note that depreciation recapture is taxed at your ordinary income tax rate up to a maximum of 25% (so it could be higher than the 15% rate you thought you would be seeing).

Ultimately, if you input the values correctly, the program will return the correct result.

[dclive]

I understand that even when converting, one keeps the purchase price of the home as the basis; that would also have been the lower of (purchase price or FMV at time of placing it as a rental).  At least, that's my recollection of the quick help in TT.

After a brief review, I can see that the $156k TT says I made in house sale is the sum of (actual increase in value of home, minus expenses) plus depreciation (6139) sum over the years it was a rental, for a sum of $156k. 

Assuming that's legit (is that how it should be?!) then why is my tax increase so high?  I see the jump from (~$3k owed to me) to (I owe $30k or so) as being an increase in $33k in taxes, but 15% of $156k is $23.5k.   How can I see where this is computed? 

[Anonymous_]

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@dclive wrote:

How can I see where this is computed? 

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Take a look at your Schedule D Tax Worksheet.

[Carl]

Understand that when you sell real estate, you are required to recapture and pay taxes on all depreciation taken. If you did not depreciate the property and it's other listed assets, then you're still required to recapture and pay tax on the depreciation you should have taken. Recaptured depreciation is taxed at the "normal" rates, anywhere from 0% to a maximum of 25%. While your gain on the sale is taxed at the capital gains tax rate. You can look at the SCH D as well as the 4797 to see the breakdown on this.

However, with the large change you mention, it "sounds" to me like you may have put a decimal point in the wrong place, somewhere.

[Anonymous_]

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@dclive wrote:

If my home goes from $250k in 2010 to $345k-ish in 2022, isn't that 95k in gains.....

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The figures you stated in the quote above do not include accumulated depreciation.

Assuming you used $250k as your basis (roughly) and had around $73k in accumulated depreciation, then your adjusted basis would be $250k less $73k or, very roughly, $177k. If you subtract $177k from $345k you wind up with $168k in gain and then subtract out your expenses of sale.

[Opus 17]

I won't comment on the capital gain figures unless you need math help that the other experts can't provide.

I do want to point out that your cleaning fees are not an allowable selling expense.  Keeping your property clean is an ordinary and routine expense for everyone and the fact that you had to clean the property for sale does not make your cleaning expenses deductible when they are not deductible for anyone else.  (They might be deductible as a rental expense on schedule E, @Carl  could answer that.).  Likewise, minor repairs are not deductible selling expenses for the same reason.

Staging fees are a deductible selling expense (as advertising) as long as there were no changes made to the home; that is, everything that was set up was taken and the home was left as-was.  

Allowable expenses are listed in Worksheet 2. https://www.irs.gov/pub/irs-pdf/p523.pdf

The idea that you can include "fix-up" expenses as adjustments to the selling price if they were made within 90 days of the sale was taken out of the tax code in 1997.

https://www.investopedia.com/terms/f/fixing-up-expenses.asp

https://turbotax.intuit.com/tax-tips/home-ownership/home-improvements-and-your-taxes/L6IwHGrx6