Sale of Rental Property cost basis with recent CAPEX

[genrlconfusion]

I've searched and searched for this answer, but haven't found a clear answer... how do I adjust cost basis for a rental house that sold but required >$100k repairs in the year it was sold to make it sellable? 

Situation: bought the house for $349 in '11 and sold it for $725 in '21, and depreciated the house plus a 2 other assets over that period.  I Spent months of 2020 fixing, updating, upgrading the house for sale after losing tenants early in 2020. I spent >$100k updating/fixing the house. So I want to adjust my cost basis to reflect the addition CAPEX spent in 2020. 

What's unclear is how to update the cost basis, do I manually change the original purchase cost, or add more assets (though I'm not sure how that helps and if there's a way to add asset as part of the sale to reflect the change to cost basis), or add up all the costs and add as Expenses, or a combination of these options.

[MarilynG1]

Since you did rent the property in 2020, enter all your Rental Income/Expenses as usual.  Indicate that you 'converted the property to personal use' in 2020.

In 2021, report the sale as 'Sale of Business Property'.   Add major improvements to the Cost Basis, lesser costs could be considered 'Sales Expenses'.  It has the same net effect either way, so don't worry about separating your costs incorrectly. 

The sale of business property generates a capital gain or loss.

Click this link for more info on Sale of Business Property. 

[genrlconfusion]

Thanks for the response.  A few follow up questions:

1. Why would I convert to personal use if I wasn't using it for personal use outside of the time it took to make the improvements and updates to sell it? 

2. Also, the confusion I have is with the sale of business property. I see the list of my property and assets and the depreciation; I click "edit" and indicate it was sold and enter the sale date, and then I'm asked the sales information (Asset sale price, expenses & Land sales price and expenses) -- Is it here where I add to the expense/improvement totals for what I spent in 2020 (dividing between asset and land fields)?  

3. How does the loan payoff amount factor into the sale price or cost of sale? I wonder if I'm inflating my gains by showing the initial cost back in 2011 then the sales price in 2020, but not the loan amount and payoff.

[DianeW777 · Accepted solution]

I would not suggest converting it to personal use, but I would indicate it was taken out of service at a certain date when it was no longer available for rent. Part of they key is that is needs to be available for rent, which it doesn't seem like it was while under repair and capital improvement.

The capital improvement will be added as sales expense next year when you sell it to make sure the costs are reflected in the sale.  However, when you take an asset (or assets) out of service it's possible those assets may not carryforward to 2021.

Keep your depreciation worksheets so that you have the information for reporting the sale in 2021.  In this scenario you will add the improvements to the original cost basis and then enter the depreciation that was used for the life of the asset(s) to determine the actual gain on the sale.

When you have more than one asset that is included in the sale (land, building, previous capital improvements) here is an example of how you apply a sales price and sales expenses to the assets at the time of your tax return sale entry.

Example:  Original Cost (of each asset on your depreciation schedule)

$10,000 Land                = 13.33% 

$50,000 House              = 66.67%

$15,000 Improvements  = 20%

$75,000 Total                 = 100%

Multiply each percentage times the sales price/sales expenses to arrive at each individual sales price/sales expense.

The loan payoff has no effect on the sale.  You have already used those loan proceeds by using the full cost basis of the rental home when you initially started your depreciation. It may seem like it is a gain inflation but it's not.

[Carl]

do I manually change the original purchase cost, or add more asset

Under no circumstances and with no exceptions do you ever change the cost of an item in the assets/depreciation list. If you do, you will completely skew the depreciation and the depreciation history on that asset.

Absolutely nothing concerning your property improvements will be placed or reported anywhere on your 2020 tax return. There are two reasons why.

1) The improvement was never placed "in service" as a rental asset in 2020

2) You did not sell the asset in 2020.

I Spent months of 2020 fixing, updating, upgrading the house for sale

So you've made it quite clear that after the last tenant moved out, you had no intention of renting the property out again. Your intention was to sell the property. Therefore, on your 2020 tax return you need to indicate that you converted this property to personal use, with a conversion date of one day after the last tenant moved out.

As you start working through that rental property about three screens in to the Property Profile section, you'll have a checkbox you need to select to indicate that you converted the property to personal use.  After you check that box, continue working through the property profile section all the way to the end. Typically, any changes/selections you make are not saved until "after" you get to a screen with a DONE button on it, and actually click that DONE button.

Then work through your rental income and rental expenses section as normal.

Then start working through the assets/depreciation section. You must do the below for each individual asset listed, one at a time.

 - Elect to EDIT the asset. As you work it through, indicate that you "stopped using this asset in 2020".

- On the "Special Handling Required?" screen you *must* select YES. If you select NO, then you will be "forced" to enter sales information. That would be wrong, since you did not sell the property in 2020.

You must do the above for each individual asset listed in the Assets/Depreciation section.

When you have completed and filed your 2020 tax return, you need to print out the two IRS Form 4562's for that property, along with the IRS Form 8582 for that property. Both of the 4562's print in landscape format. One is titled "Depreciation and Amortization Report" and the other is "Alternative Minimum Tax Depreciation".

You will "NEED" the information on those documents next year, when you report your sale on your 2021 tax return. You will be reporting this sale in the "Sale of Business Property" section on your 2021 tax return, which you will not deal with until next year. When you report this sale in the "Sale of Business Property" section on your 2021 tax return next year, that is when you will add the cost of your property improvements to your cost basis, and not before.

[Dixie1500]

Where can I enter this information

[Carl]

@Dixie1500 your post is what is referred to as an "add-on" to this thread, since you did not start this thread. Because of that, it's a wild guess of what you're referring to for "your" specific situation. It would probably be best if you start your own thread and provide the details of your specific situation.

But basically, using the information in this thread that you did not post (and therefore don't know if it applies to your "specific" situation) after converting the property to personal use and having printed out the two tax year 2021 form 4562's for that specific property, the sale would be reported on the 2022 tax return in the "Sale of Business Property" section. The cost basis would be the total cost basis of all listed assets shown on the 4562, plus the cost of improvements done after the last renter moved out. When asked for the total of all depreciation taken, that's also shown on the prior year 4562's for that specific property and it's assets.