When I sell a rental property are any of the real estate closing fees tax deductible?

[Anonymous]

@Carl :

As @nholdway  said "So how do you spread the sales price (and the expenses of the sale) over the depreciating assets? Proportionally? Like, I had electrical rewiring done -- I have to figure out some sort of sales price for it?"

I have been depreciating a $20K remodel, appliances, and refinance points along with the frame rental house.  I did make a profit on the sale, so how do you apply sales price to these assets (knowing that they are part of the "property improvement" portion of the sale and not the land portion).

[Carl]

I'll give an example. First a reminder. As you know, the cost basis and sales price of the non-depreciable land asset will not change for any reason. (I'm assuming the land is the only non-depreciable asset you have.)

I purchased property in 2000 for $100,000. Allocated $30K to the land which means the remaining $70K is the structure value, and that's the value being depreciated over the next 27.5 years.

In 2005 The central A/C died and I purchased a new A/C (both inside blower and outside compressor) at a cost of $10,000. Since that becomes "a material part of" the property it gets classified as residental rental real estate and depreciated over 27.5 years just like the rental property.

In 2010 the refridgerator died. I purhcased a new refridgerator for $1100. Since that's not "a material part of" the rental property it get's classified as equipment (Tool, Machinery, Equipment, Furniture in TurboTax) and depreciated over 5 years.

In 2019 I sell the property. First, I need to figure the total cost basis.

Paid for house/land - $100,000  Depreciation taken as of sale date in 2019 - $47,000

New A/C system - - -    $10,000 Depreciation taken as of sale date in 2019 - $4,500

New refridgerator - -      $1,100 Depreciation taken as of sale date in 2019 - $1,100 (completely depreciated)

TOTAL - - - - - - - - - - - $111,100  Total depreciation taken on all assets - - - -   $52,600

My cost basis in the land is still $30K. My cost basis in the remaining depreciable asstes is $81,000.

My sales price is $200,000.

At this point, I'm going to allocate $40,000 to the sales price of the land. That gives me a $10K gain on the sale of the land. I have $160,000 of my sales price left to allocate. This will be allocated across my depreciated asset only. (which includes the rental structure.)

Now, I need to allocate the remaining sales price across these assets. Since I sold the property at a gain, I need to actually show a gain in each asset - even if that gain is only $1 on some assets. The allocated amount needs to be at least $1 above the "cost basis".

So of the remaining $160,000 of my sales price left to allocate, I"m going to allocate $140,000 to the structure, $15,000 to the A/C and $5,000 to the refrigerator. I've now shown a gain on each and every asset.

Understand that you don't have to allocate your sales price proportionately. It should be obvious above that I most certainly didn't. But it doesn't matter. What does matter is that if you sold the property at a gain, then you must show a gain on every listed asset. Even if that gain is only $1 on some assets.

Likewise, if you sold the property at a loss, then you must show a loss on all assets, even if that loss is only $1 on some assets.

If I just report the property sold for $200,000 and the assets sold for $0, that shows a loss on some assets and a gain on others. On those assets that have not been fully depreciated yet, the program will do the math wrong and not recapture that depreciation. That makes the 4797 and SCH D flat out wrong. Sometimes the program can handle this. But more often than not it screws things up on the 4979 and SCH D. When that happens the program checks do not see this as an error. They see the sale of that asset as a loss is all. You will also be able to e-file successfully with no problem and the IRS computers will accept the e-filed return.

But in the review it's very likely the depreciation recapture will not be correct - particularly on those assets that you show a loss on when you in fact sold the property at a gain. This generates a nasty gram from the IRS, and you don't want that.

[nholdway]

This is excellent. That the IRS doesn't require proportional allocation of the sales price among all the assets is ... bonkers, as many IRS regs are -- I did figure it that way. But I guess it doesn't matter because the totals come out the same and therefore the income to be taxed will come out the same.

I don't think anyone has answered my question on whether the real estate taxes listed as part of the closing costs are figured into the expenses of the sale (effectively adding to the cost basis), as opposed to being figured into the taxes on Schedule E (along with the taxes paid before the sale), but it looks to me from reading elsewhere that they indeed would be figured into the expenses of the sale.

[Carl]

That the IRS doesn't require proportional allocation of the sales price among all the assets is ... bonkers, as many IRS regs are -- I did figure it that way

While you can allocate proportionally, there's no need. Regardless of how you allocate, it will not change the "bottom line" gain or loss, provided you follow the two simple rules in the allocation process.

1) If sold at a loss, then you show a loss on all assets - even if that loss is only $1 on some assets.

2) If sold at a gain, then you show a gain on all assets - even if that gain is only $1 on some assets.

[Carl]

It was actually sold for $40K less than what it was purchased for previously 9 years ago

Actually, its possible you sold at a gain. Remember, in the year you sell rental property you are required to recapture all prior depreciation taken on the property. You show that recapture by adding that depreciation to your sales price. Then, if that adjusted sales price is more than your cost basis in the program, you sold at a gain. Of course, depending on how close the adjusted sales price is to your cost basis, once allowed deductions are taken into consideration, that gain could be offset and become a loss.

[TheColonel19438]

Great example. What if I sold my rental property for the exact price I bought it for?  How would that affect the technique of showing a gain or loss consistently across all the assets. I also have some capital improvements that I never put into service and would like to get credit for to help offset the gain brought on by the building depreciation.  Thank you in advance!

[suavecito170]

Hello,

I am struggling with how to allocate assets, we have refinancing costs, a fridge, and a washer and dryer. We sold our rental for a gain but we are exempt from capital gains due to being military and moving on orders. Do I mark all the assets as $0 for sale price besides the actual rental? And what about the land sales price for the actual rental ( I have an appraisal with a value for the land?

[DanielV01]

@suavecito170  You might have some of the tax laws confused.  You are correct that if you are selling your primary residence, that such is exempt from capital gains (up to 250,000 for an unmarried individual, or 500,000 for a Married Couple filing Joint).  For most taxpayers, they qualify for the exclusion if they have lived in the house for 2 of the last 5 years (24 of the last 60 months).  As a military member on PCS orders, the exclusion for such a sale is extended for 10 additional years.  However, depreciation taken (or allowable) on the home is still subject to recapture.

An example:  You purchased a home in 2012 for 200,000, and after living in it for two years, moved due to PCS orders in 2014.  You began to rent the home and had occupants there for 6 years until 2020.  Because of the appreciated marked, you were able to sell your home for 500,000.  You are filing as Married Filing Joint.  It the same time period, you were allowed to take $50,000 of depreciation on the home (a round number for the sake of the example), and you did take all of the depreciation you were allowed.  You also have other expenses (closing costs, refinancing costs, etc.) that in total add up to $20,000.  Land for your circumstance will be moot because of the exclusion (land does not depreciate).  Here's what you end up reporting (not necessarily what you input):

• Sales price:  500,000
• Original purchase price:  $200,000
• Depreciation allowable:  $50,000 (takes the basis down to $150,000)
• Adjustments to basis (other costs):  $20,000 (brings basis back up to $170,000
• Capital gains:  $330,000
• Amount of capital gains excludable:  $500,000
• Capital gains excluded:  $330,000

That seems to be $0 taxable income, but it's not.  You must report the proper figures because you are subject to depreciation recapture.  In this example, the $50,000 is still subject to ordinary tax as depreciation recapture.  But you can lump all of the other expenses as adjustments to basis as long as the sales price of the home-adjusted basis is less than the exclusion amount.  Comment if that is not the case for you.

This Help Article will guide you to enter the sale of your rental accurately:  I sold my rental property. How do I report that?