@Carl et al... Need some guidance. Bought my condo in 1999 for $92,000. Bought/moved into another primary residence in August 2009 and put the condo in service as a rental. Sold the condo (still was a rental) in August 2022 for $342,000. What should I use as cost basis for the sale? The original purchase price of $92k? Or FMV at the time I converted it to a rental in Aug 2009 (need to verify with comps that sold around that time, but FMV was probably around $200-250k at that time)? Note: I've been using TurboTax which has been depreciating the condo since put into service as a Rental (using $92000 as depreciation cost basis).
Also, how do I include closing costs and commissions paid at the time of the 2022 sale along with capital improvements into the cost basis? It seems that for capital improvements, TurboTax depreciates these over several years, so if I did the improvement (e.g new tile flooring, new hot water heater, new heat pump, etc) more than few years ago, it is not showing any remaining depreciation and not reducing the capital gains that I owe.
Thanks for your help!!
The starting cost basis is the $92K that you originally purchased it for.
Capital improvements should have been added to the cost basis or posted separately to a depreciation schedule. They should not be expensed.
If they're completely depleted, you will not get any future benefit from them.
However, there will be “Depreciation recapture” this refers to the Internal Revenue Service's (IRS) policy that an individual cannot claim a depreciation deduction for an asset (thereby reducing their income tax) and then sell it for a profit without “repaying the IRS” through income tax on that profit. TurboTax will handle this for you. Depreciation Recapture
Sellers can deduct closing costs such as real estate commissions, legal fees, transfer taxes, title policy fees, and deed recording fees to lower the profit and lower the potential taxes owed.
If this does not completely answer your question, please contact us again and provide some additional details.
Thanks @JohnB5677 for the response. Where in Turbo Tax do I enter the Capital Improvements? I've only seen an area to enter these under "Your Property Assets" (on the Schedule E Worksheet when I go to Forms). And where do I enter all of the Closing Costs from the sale? Thanks!
You should be posting this to step by step, but if you posted it to the form I don't want it duplicated.
If you have not posted it. Go to:
TurboTax CD/Download
You can post all of the closing cost deductions directly as expenses.
When you go through the interview, you will come to Review Your (Property) Summary
You can select Expenses and post the closing cost expense.
What should I use as cost basis for the sale? The original purchase price of $92k?
Bear with me while I state what may be obvious for the sake of clarity.
When you converted the property to a rental in 2009, you were required to depreciate it. The amount used for depreciation is based on the *LESSER* amount of:
1) What you paid for it when you originally purchased it, or;
2) The FMV of the property on the date you converted it.
By your own statement, what you paid for the property when you originally purchased it is the *lower* amount, and is what you were required to use (and should have used) for depreciation of the property. The actually amount depreciated would actually be much lower than the original $92K you paid for it, because the value of the land is never depreciated. Only the value of the structure on that land is depreciated over 27.5 years.
Assuming you set things up correctly in Turbo Tax back in 2009 when you converted the property to a rental, you can use the below guidance to report the sale in the SCH E section of the program. The program (not you) will take care of all depreciation recapture as well as any PAL carry over losses if you have those, which are released and fully deductible from all other "ordinary" income in the tax year you sell the property.
Once done with the below, you can (and should) review the Form 4797 and SCH D that will be generated by the program for reporting this sale to the IRS.
As a note, since the property was not your primary residence for at least 2 of the last 5 years you owned it, you do not qualify for the capital gains tax exclusion, assuming you are not active duty military. Please read the below completely before you do anything. Otherwise, you risk incorrect reporting and the possibility of paying more tax than you should.
Reporting the Sale of Rental Property
If you qualify for the "lived in 2 of last 5 years" capital gains exclusion, then when prompted you WILL indicate that this sale DOES INCLUDE the sale of your main home. For AD MIL personnel who don't qualify because of PCS orders, select this option anyway, because you "MIGHT" qualify for at last a partial exclusion.
Start working through Rental & Royalty Income (SCH E) "AS IF" you did not sell the property. One of the screens near the start will have a selection on it for "I sold or otherwise disposed of this property in 2021". Select it. After you select the "I sold or otherwise disposed of this property in 2021" you continue working it through "as if" you still own it. When you come to the summary screen you will enter all of your rental income and expenses, even if it's zero. Then you MUST work through the "Sale of Property/Depreciation" section. You must work through each individual asset one at a time to report its disposition (in your case, all your rental assets were sold).
Understand that if more than the property itself is listed in your assets list, then you need to allocate your sales price across all of your assets. You will only allocate the structure sales price; you will NOT allocate the land sales price, since the land is not a depreciable asset. Then if you sold this rental at a gain, you must show a gain on all assets, even if that gain is $1 on some assets. Likewise, if you sold at a loss then you must show a loss on all assets, even if that loss is $1 on some assets.
Basically, when working through an asset you select the option for "I stopped using this asset in 2021" and go from there. Note that you MUST do this for EACH AND EVERY asset listed.
When you finish working through everything listed in the assets section, if you ever at any time you owned this rental you claimed vehicle expenses, then you must also work through the vehicle section and show the disposition of the vehicle. Most likely, your vehicle disposition will be "removed for personal use", as I seriously doubt you sold your vehicle as a part of this rental sale.
Great, thanks! (I am filling it in using "Easy Step", but just toggled to "Form" earlier to provide some additional detail to you. I will follow the steps you provided. Thanks!
One last question... For one of the capital improvements (new tile floor), I placed in service 3/7/2018 and started depreciating that cost starting on my 2018 return. It's now all depreciated (Depreciation amount shows as zero), but $2265 shows up under the Section 179 column on the "Your Property Assets" screen. How should I handle this as far as showing it as a Capital Improvement to increase my cost basis/lower my capital gains?
Thank you @Carl. Yes, I've been depreciating the condo on a 27.5 year cycle and TurboTax seems to be handling the Depreciation Reclamation. I am not AD MIL and did not live in the unit for 2 out of 5 years.
I'm still confused on Capital Improvements. My understanding was that the calculation for Capital Gains was Capital Gains = (Sale Price) - (Real Estate Commission) - (Purchase Price) - (Capital Improvements) + (Depreciation Claimed) = Amount to be taxed at 15% Capital Gains
But I do not know where to add it the Capital Improvements so that they will lower my taxable cost basis. I've made several Capital Improvements over the 20+ years that I've owned the unit. Would you please provide some guidance/clarity on this point? In TurboTax, I have 3 items listed in "Your Property Assets" that show depreciation: 1) The condo itself (with the yearly depreciation on the 27.5 year term), 2) 2016 Refinancing fees (still has some depreciation), and 3) the floor/tile upgrades I did in 2018 (I must have entered this in 2018 to depreciate, and it shows zero Depreciation but $2265 under Section 179 column). I'd like to include this tile upgrade as part of the Capital Improvements. So back to my original question, where do I enter Capital Improvements? Also, can I still claim the above tile upgrade as a Capital Improvement? Thank you!
but $2265 shows up under the Section 179 column on the "Your Property Assets" screen. How should I handle this as far as showing it as a Capital Improvement to increase my cost basis/lower my capital gains?
Apparently, when you entered the asset, you elected to take the SEC179 depreciation option. That allows you to fully depreciate the asset in the tax year you placed it in service. It does not change the fact that you are required to recapture that depreciation in the tax year you sell the property.
But I do not know where to add it the Capital Improvements so that they will lower my taxable cost basis.
The capital improvements are already there, listed in the Assets/Depreciation section. Or are you saying you have capital improvements you did not enter at the time you placed them in service?
@Carl "Or are you saying you have capital improvements you did not enter at the time you placed them in service? "
=> Yes, this is exactly what I am saying. I never entered them in my taxes (either I was living their as primary before converting it to a rental, or didn't realize to enter these for deduction/depreciation in that year). So how do I capture all of the capital improvements that I've done over the years to improve the residence (both before it was a rental and after it became a rental)? This is what I am trying to figure out as I do not see the appropriate place to enter these capital improvements.
I never entered them in my taxes
You need to RUN to a tax professional. Especially if your state taxes personal income, as that can be a double-whammy. A tax professional may be able to keep your fines, penalties and back taxes minimal.
I think you are misconstruing what I said. I've claimed/paid my taxes honestly every year, and have receipts to back up all. My understanding is you can claim Capital Improvements that you've made to lower your cost basis when you sell your rental per the IRS tax formula Capital Gains = (Sale Price) - (Real Estate Commission) - (Purchase Price) - (Capital Improvements) + (Depreciation Claimed) = Amount to be taxed at 15% Capital Gains
What I am asking is: 1) Can you only claim Capital Improvements made after the unit was put into service as a rental? (e.g. If I replaced heat pump while it was still my primary residence and not yet a rental, can I claim that as a Capital Improvement?)
2) For all of the Capital Improvements I've done to the condo (before and after it was put into service as a rental), for which I have all receipts, where do these get entered into TurboTax? Is there a Rental Sales Cost Basis Worksheet, for example? Some of the Capital Improvements which occurred when I lived their as my primary (e.g. the new heat pump) was never entered because it was not a rental at the time and there was no reason to enter it (e.g. I couldn't depreciate it, again, because it was my primary and not a rental).
So I am looking to find out how/where to address Capital Improvements in TurboTax. I am sure that others have had this exact situation. Thanks for your continued help!
I think I found the answer on the IRS website: https://www.irs.gov/taxtopics/tc414
You can recover some or all of your original acquisition cost and the cost of improvements by using Form 4562, Depreciation and Amortization (to report depreciation) beginning in the year your rental property is first placed in service, and beginning in any year you make improvements or add furnishings.
1) Can you only claim Capital Improvements made after the unit was put into service as a rental? (e.g. If I replaced heat pump while it was still my primary residence and not yet a rental, can I claim that as a Capital Improvement?)
"ALL" improvements done since your qcquisition of the property are added to the cost basis. Property improvements done before you converted the property to a rental "should" already be included in the cost basis. They could either be added to the original cost basis, or listed as a separate asset with the same in service date as the property, if done before the in service date.
2) For all of the Capital Improvements I've done to the condo (before and after it was put into service as a rental), for which I have all receipts, where do these get entered into TurboTax?
Again, if you've been doing things right in the past as you state, they are already listed in the program in the assets/depreciation section. If your heat pump done before you converted to rental isn't listed separately, then it "should" be included in the cost basis of the property.
Is there a Rental Sales Cost Basis Worksheet, for example?
There are two "unofficial" form 4562's in your tax return. They both print in landscape format. One is titled "Depreciation and Amortization Report" and is most likely the only one you'll use. The other is titled "Alternative Minimum Tax Depreciation" and is only used if you were required to pay AMT at any time during your ownership.
Some of the Capital Improvements which occurred when I lived their as my primary (e.g. the new heat pump) was never entered because it was not a rental at the time and there was no reason to enter it (e.g. I couldn't depreciate it, again, because it was my primary and not a rental).
It does not matter when the heat pump was installed; before or after converting to a rental. If you did not include it one way or another in the Assets/Deprecation section at the time you converted the property to a rental, yet you want to include it now to "increase your cost basis", you have a problem.
When you do not depreciate an asset as required, then when you sell that asset you are required to recapture the depreciation you *should* have taken, and pay taxes on that recaptured depreciation. So you still lose. The correct way to "fix this" is to file IRS Form 3115. While that form is included in the TTX program, it is not simple by any stretch of the imagination. That's why you need to seek professional help. Doing the 3115 wrong can (and will) put you in a never-ending nightmare with the IRS, from which you will never awaken.
I am sure that others have had this exact situation.
Many have.... and as far as I can tell by their responses, a vast majority (if not nearly all) of them took the advice provided and sought out professional help.
See IRS Publication 946 at https://www.irs.gov/pub/irs-pdf/p946.pdf starting at the end of page 13, "Change Your Accounting Method".
If you're going to add the heat pump or any other asset that you did not depreciate when you should have, then you'll have to include the 3115 with your return.
As I said, it's not simple.
Thank you. I'll probably opt not to enter them at this point and chalk it up to missed opportunity. I didn't realize that they needed to be entered at the time I converted to rental. Changing 14 years of taxes does not sound like a fun endeavor. Thanks again!
a bit dated.. spend time reading the thread but was hoping to see a response to your final conclusion i.e. "chalk it up to missed opportunity"
to recap, what i understand that there were improvements either before or after putting into service (rental) that were missed to be reported as an "asset" and therefore depreciated. the feedback from the community was "seek professional tax help to process for 3115" as it is a big deal...when you go to claim these improvements as a basis increase during sale and therefore lower your gains, you will be paying depreciation recapture on these assets even if never depreciated.... so i see 3 options ... would be great if someone can comment if these are possible.... let's assume the improvements are minimal e.g. 5K HVAC
Option 1) including the 5 K in the basis but also file 3115 to change accounting to depreciate the asset properly as it was never depreciated... then pay recapture on the depreciation...
Option 2) including the 5 K in the basis and pay recapture on the depreciation (that was never taxation)... feels like a lost opportunity but might still be financially advantageous if there is enough life left.. say asset was only 1-2 yr old. is this allowable? (i.e. save 2K on CPA fees to file 3115 as the HVAC has little impact)
Option 3) this is the option OP indicated at the end. Ignore the entire HVAC 5K improvement. assume was never done. do not use it to increase your basis for the sale and do not worry about depreciation. is this allowable?
Yes, you have options:
1. Include the HVAC in the basis and pay the taxes.
2. Include the HVAC in the basis and pay the taxes. File form 3115
3. Ignore the HVAC expense
4. Amend prior returns to include the HVAC expense and depreciate it since it is less than 3 years old. You will get a refund plus interest.
The IRS requires you to depreciate the house but it does not require you account for every expense.