Case Study - Partially Residential Property
Tom Stonehouse, a 72-year-old taxpayer, owns a four-unit apartment building that he had purchased five years ago. He occupies one unit as his personal residence and rents out three units. Desiring to move to a warmer climate, Tom decides to sell the building and move in with his nephew. Tom's records show the following:
| Cost of building |
$80,000 |
| Capital improvements |
+ 8,000 |
| |
$88,000 |
| Less: Depreciation on rental units |
-10,100 |
| Adjusted basis |
$77,900 |
Tom sells the building on May 1, 2013, for $220,000 and incurs selling expenses of $10,000. Since only one-fourth of the building was used as his personal residence, Tom would compute his gain as follows:
| |
Apartment Residence |
Rental Building |
| Usage allocation |
(1/4) |
(3/4) |
| (1) Selling price |
$ 55,000 |
$165,000 |
| (2) Selling expenses |
- 2,500 |
- 7,500 |
| (3) Amount realized (adjusted sales price) |
$ 52,500 |
$157,500 |
| (4) Basis (including improvements) |
$ 22,000 |
$ 66,000 |
| (5) Depreciation |
|
- 10,100 |
| (6) Adjusted basis |
$ 22,000 |
$ 55,900 |
| (7) Realized gain ((3) minus (6)) |
$ 30,500 |
$101,600 |
| (8) Gain subject to exclusion |
$30,500 |
|
| (9) Gain subject to tax |
|
$101,600 |
Of the gains subject to tax on line (9), $10,100 is taxed at a 25 percent rate because it represents depreciation that must be recaptured. The remainder would be taxed at a maximum rate of 15 percent.
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Warning
Beginning in 2013, a new 3.8 percent net investment income tax may be imposed on individuals whose modified adjusted gross income exceeds $250,000 for joint filers, $125,000 for married taxpayers filing separately, and $200,000 for others. Trusts and estates with income over a certain amount are also subject to the NII tax. Form 8960, Net Investment Income Tax— Individuals, Estates, and Trusts is attached to the tax return. For 2013, the IRS has provided taxpayers the ability to rely on more than one set of net investment income tax rules. The best choice varies by taxpayers and depends on the taxpayer's unique situation. Consult your advisor to determine which approach would be best for you.
Also, note that the IRS has issued new depreciation regulations that generally apply to tax years beginning on or after January 1, 2014. But, for 2012 and 2013, it also provided taxpayers with the ability to elect certain regulations. The best choice for each taxpayer depends on the taxpayer's unique situation. Consult your advisor to determine which approach would be best for you and your business.
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