Depreciation Recapture and Net Investment Income Tax

[wully7309]

Hello - I plan to sell the house and have the following questions:

1) I will definitely be above MAGI of $250k (MFJ). Will an additional 3.8% be applied to BOTH LT gains (15%) and depreciation recapture (24% - my tax bracket), i.e., depreciation recapture will be taxed at 27.8%? Confused.

2) If I make house improvements in the year I sell - do I add those house improvement costs to the cost basis to reduce taxability?

[wully7309]

Can one experienced in this - advise? Thank you

@LeticiaF1, @xmasbaby0  @tagteam @DianeW777

[wully7309]

Experts can you please advise?

@LeticiaF1, @xmasbaby0  @tagteam @DianeW777

[Mike9241]

"If I make house improvements in the year I sell - do I add those house improvement costs to the cost basis to reduce taxability" answer is yes

NII includes

1) rents and income unless derived in the ordinary course of a trade or business that is not a passive activity

2) net gain attributable to the disposition of property other than property held in a nonpassive trade or business. However, gain or loss from the sale of property held in a trade or business in which the taxpayer materially participates is not NII 

examples of 2) gain from the sale of investment real estate and gain from sale of residence in excess of the applicable exclusion. Gain includes depreciation recapture. 

The NIIT tax is computed on the lower of NII or modified AGI in excess of the exclusion for your filing status.

you do have the option of doing a 1031 exchange (assuming it's not your home) to avoid the NIIT. This should be discussed with a tax pro so if it's done it's done properly.  

[wully7309]

Thank you. Can you advise - what value does 1099-S show - is it a gross sold price of the rental house or something else? I am trying to understand better how I adjust my cost basis and adjust sales price for closing costs.

Also: I just learned that there will be an underpayment penalty. If you sold a house, i.e., had a big capital gain event (significant taxable income increase from the previous year), how did you manage to make prepayments to avoid tax penalties (LINE 38 in 1040)? I am a bit confused, as it seems one must make prepayments each quarter. Can one just make one lump sum prepayment before Dec 31?

See the reference here: https://www.hrblock.com/tax-center/irs/tax-responsibilities/avoiding-underpayment-tax-penalty/#:~:te...

@Mike9241 

[Mike9241]

1099-s only shows the gross sales price. it excludes closing costs. your gain is the 1099-S less the cost of property including any improvements reduced by the higher of depreciation allowed or allowable (this means if you too much it's recapturable. if you took too little you need to adjust for the proper depreciation - too little means you would need to file form 3115 to adjust for the proper depreciation); less selling expenses/closing costs. These would nbe shown oin the closing statement. Not all closing costs are selling expenses. For example prorated real estate taxes, mortgage interest, utilities, HOA fees go on schedule E. 

selling expenses might include these expenses imposed on the seller: transfer tax, home warranty fee, real estate sales commission, inspection fee, seller credits 

Turbotax does make it a little difficult to handle the sale of rental property when there are multiple assets involved, since to get the correct results, sales proceeds and selling expenses must be allocated to each asset. Miss any and the net tax basis will not be included in computing gain or loss. 

[wully7309]

Thank you very much. You helped a lot. Not related to depreciation recapture but related to rental property sale:

I just learned that there will be an underpayment penalty. If you sold a house, i.e., had a big capital gain event (significant taxable income increase from the previous year), how did you manage to make prepayments to avoid tax penalties (LINE 38 in 1040)? I am a bit confused, as it seems one must make prepayments each quarter - is it applicable to me (I am a W2 employee)? Can one just make one lump sum prepayment before Dec 31 and how to avoid the tax penalty for underpayment when huge capital gain tax is expected from rental property sale?

See the reference here: https://www.hrblock.com/tax-center/i...0and%20credits

@Mike9241 

[Mike9241]

the 2210 default is that 1/4 of your required minimum payments is due 4/15,6/15,9/15 and 1/15 of following year. when you have uneven income especially later in the year the only way to possibly avoid these penalties is to use the annualized income installment method on page 3 of 2210. 

the tax is figured for each period 

22.5% of the taxes based on the deannualized taxes on your income for the period 1/1-3/31 must be paid by 4/15

45.% of the taxes based on the deannualized taxes on your income for the period 1/1 - 5/31 must be paid by 6/15

67.5 of the taxes based on the deannualized taxes on your income for the period 1/1-8/31 must be paid by 9/15

90% of the taxes for the whole year must be paid by 1/15/2024 - note that for this purpose withholding is only through 12/31

another possibility if you had uneven withholding is to use actual for each period. the default is 25%

evidently you do not meet any of the safe harbor tests.

There will be no federal penalties for not paying in enough taxes during the year if withholding and

1. timely estimated tax payments equal or exceed 90% of your 2024 tax or
2. timely estimated tax payments equal or exceed 100% of your 2023 tax (110% if your 2023 adjusted gross income was more than $150K) or
3. the balance due after subtracting taxes withheld from 90% of your 2024 tax is less than $1,000 or
4. your total taxes are less than $1,000

state laws differ

[wully7309]

Mike9241—Thank you. I am a bit confused. My wife and I have a steady income above $150k AGI. 

We will sell a rental property this year and expect an LT capital gain of ~$200k. 

What do I need to do to prevent tax penalties for 2024 when filing taxes in 2024?

I need simple explanation if possible