Capital Gain

[user17684044706]

My father is 74 years old and lives in California. He is selling his property that he was renting for the last 20 years. He will be selling it for $320,000.00. He will be receiving about 289,000.00 cash. My questions is, will he need to pay taxes on on the amount he is receiving? If so, what would be the estimate he would have to pay? He is retired and hasn't filed taxes in the last 10 years, or longer. Thank you

[M-MTax]

If he bought the property, then we need to know the purchase price plus the cost of any improvements made to determine your father's basis in the property. The gain would be the sales price (less selling expenses) minus his basis.

Assuming the property is improved (i.e., has some sort of structure), part of the gain (if any) would be Section 1250 gain (depreciation recapture over the 20-year period of rental) which would be taxed at ordinary income tax rates (up to a maximum of 25%) while the rest of the gain would be taxed at the long-term capital gains tax rate (up to a maximum o 20%). There is also the NIIT of 3.8% depending upon whether his net investment income exceeds $200,000.

[user17684044706]

He purchased the property in 1993 for $88,000.00. He did paint the house recently (is the only upgrade done) and paid $4,400.00 for that job. 

[M-MTax]

Painting would be an expense, not an improvement, and. as such, would not be added to his basis.

[M-MTax]

You wrote that he had rented it for 20 years, so you need to know the fair market value at the time of conversion to rental use for depreciation purposes. His gain, however, appears to be substantial based upon the purchase price. 

Obviously, he has owned it for far longer than the rental period. Regardless, if he started renting it in 2005 or 2006, his accumulated depreciation is substantial, and he will be subject to Section 1250 (i.e., recovery of accumulated depreciation deductions).

[Opus 17 · Accepted solution]

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@user17684044706 wrote:

He purchased the property in 1993 for $88,000.00. He did paint the house recently (is the only upgrade done) and paid $4,400.00 for that job. 

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Yes, he must report the gain and pay capital gains tax.  His gain is the difference between his cost basis and the selling price, and may have no relationship to the actual amount of cash. 

His cost basis what he originally paid, minus depreciation he took or should have taken while he was renting the property.  For 20 years and a purchase price of $88,000, he probably took about $59,000 of depreciation, leaving an adjusted cost basis of around $29,000.

His selling price can be reduced by certain selling expenses such as advertising and real estate commission.  Let's say for the sake of argument that his total expenses are 10%, so his net selling price is $288,000 (his real expenses might be more or less). 

That means his capital gains is (from these example numbers) $288,000-$29,000=$229,000.

The first part of capital gains that came from depreciation is taxed as depreciation recapture, which is taxed as ordinary income with a maximum of 25%.  The rest of the capital gains will be taxed by the IRS as a long term capital gains at 0%, 15% or 20%, depending on your father's other income.  California will tax the entire gain as regular income. 

[M-MTax]

@user17684044706 

Why has you father not filed tax returns for the past 10 years? He has rental income, correct? What is the approximate figure on an annual basis and what are the expenses incurred? Has he had any other type of income during that period?

[M-MTax]

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@Opus 17 wrote:

For 20 years and a purchase price of $88,000, he probably took about $59,000 of depreciation...

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He didn't take anything for the last 10 years since he didn't file tax returns for the last 10 years.

We also don't know what type of "property" this happens to be since @user17684044706 did not specify that in the original post. It could be anything from residential real estate to nonresidential real estate to vacant land.

We also don't know if there are any passive loss carryforwards and, if so, the total amount. That could greatly affect the amount of gain on this transaction.

[M-MTax]

@user17684044706 

You have a LOT of complicating factors here and need a tax professional to unravel this situation.

The answer provided by @Opus 17 makes too many assumptions and leaves out the aforementioned complexities.

[Mike9241]

It's unclear, but if he was renting during the last 10 years, even though he didn't file, depreciation was allowed under the tax laws.  The tax laws say a taxpayer must use the higher of depreciation taken or allowable in computing gain/loss.    How much cash he receives is irrelevant. His gain is Gross sales price less selling costs. less tax basis (cost reduced by depreciation higher of allowed or allowable). For rental real estate, depreciation would be recaptured as a Section 1250 gain, which has a preferential tax rate. Since the property was disposed of he's allowed to deduct suspended losses. However, its possiblle that he had an NOL in some of those 10 years. The fact that no return was filed for 10 years potentially creates issues for which a tax professional would be needed

[M-MTax]

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@Mike9241 wrote:

The fact that no return was filed for 10 years potentially creates issues for which a tax professional would be needed

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Exactly! There is also a ton of information that has not been provided in the original and subsequent posts, such as the type of property rented, value of the land (if applicable, and this could be vacant land - we don't know).

A tax pro is definitely called for in this instance since a 3115 might need to be filed for any foregone depreciation.

[Opus 17]

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@M-MTax wrote:

@user17684044706 

You have a LOT of complicating factors here and need a tax professional to unravel this situation.

The answer provided by @Opus 17 makes too many assumptions and leaves out the aforementioned complexities.

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The gain includes depreciation recapture based on depreciation he claimed or could have claimed, even if he didn't claim it.  A 2025 return can be prepared based on the known facts without fixing prior mistakes.  There may be other very good and important reasons to file the correct prior tax returns.  

[M-MTax]

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@Opus 17 wrote:
The gain includes depreciation recapture based on depreciation he claimed or could have claimed, even if he didn't claim it.  A 2025 return can be prepared based on the known facts without fixing prior mistakes.  There may be other very good and important reasons to file the correct prior tax returns.  

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The problem is (a) a 3115 would need to be filed to make an adjustment for the depreciation that was not claimed on returns since no returns were filed, (b) your numbers are likely way off because there might have been suspended passive losses and/or the value of land was included in the depreciable basis, and (c) we actually don't know what type of property this happens to be (residential, nonresidential, vacant land). 

Again, @user17684044706 could not simply file prior returns to claim the foregone depreciation; a 3115 would need to be filed and that's not really a DIY project. 

Lastly, there are just too many facts missing to make any kind of assessment other than recommending a consultation with a tax professional.