ark@alice.UucP (Andrew Koenig) (07/16/86)
> Suppose a person buys a condo for 50K sales price but has > a basis of 35K after builder kickbacks/incentives/etc. > The condo is depreciated at 5K per year for 2 years and > then sold for 40K. Now, just to make a real mess, suppose > the outstanding mortgage balance on the unit is 45K. > > A simple question: I believe that the basis is 25K and you'd > have to pay long term gains on 40K - 25K = 15K, irregardless > of the outstanding mortgage balance. True or false? True, as far as I know. And the mortgage balance has nothing to do with it.
rdr@inuxh.UUCP (07/18/86)
> > Suppose a person buys a condo for 50K sales price but has > > a basis of 35K after builder kickbacks/incentives/etc. > > The condo is depreciated at 5K per year for 2 years and > > then sold for 40K. Now, just to make a real mess, suppose > > the outstanding mortgage balance on the unit is 45K. > > > > A simple question: I believe that the basis is 25K and you'd > > have to pay long term gains on 40K - 25K = 15K, irregardless > > of the outstanding mortgage balance. True or false? > > True, as far as I know. And the mortgage balance > has nothing to do with it. Not exactly... If you're depreciating the condo at 5K per year, you are obviously using the accelerated depreciation (ACRS) instead of the straight-line method. When you do this, part of the gain is taxed at short term rates and part is taxed at the capital gains rate. In general, the portion of the gain equal to the difference between the ACRS and the straight-line method is taxed at short-term rates no matter how long you held the property. In your case it would look like this: Suppose you used straight line depreciation over 19 years: you would depreciate 35K/19 or $1944 per year, or $3889 over two years. Your gain would be $40K - ($35K - $3889) = $8889. It would be taxed at the capital gains rate. If instead you used ACRS, you depreciate $5K per year (I'll use your number) your gain would be $40K - ($35K - $10K) = 15K, as you calculated. But you can only claim $8889 of the 15K as long-term gain; the rest, $6111 attributable to your using ACRS (the IRS calls it "excess depreciation"), will always be taxed at the regular rates. Why do they do this? It makes straight-line and ACRS more equitable. When you sell a piece of property you are sort-of paying back the depreciation you wrote off in earlier years. But, if you took straight-line depreciation you only have to pay back 40% of it (the capital gain rate). One of the tax advantages of real estate. But if you use ACRS, you get to deduct much more in the early years, and have more to "pay back" if you sell before the property is fully depreciated. Uncle Sam doesn't let you pay back just 40% of all that extra depreciation - you have to pay back ALL of that extra depreciation. In short, you only get the capital gains advantage on the straight-line portion of the depreciation (plus any appreciation). Should you use straight-line or ACRS? It all depends. If you will be in a lower tax bracket when you sell than when you depreciate, then take the ACRS - the above example assumes you were in the same bracket. If you are in a lower one, then you effectively don't have to pay back all the depreciation. If you are in steadily increasing tax brackets and keep properties a long time, then take the straight-line - you will have larger write-offs in the later years than with ACRS. But be sure when you buy the property to pick the one you want. You can apply to change your method later on, but I'm told the IRS rarely approves except in very unusual circumstances. Oh, the usual disclaimer... this is the way I interpret the IRS sansgrit - your interpretation may vary. I really don't know what I'm talking about so don't take my advice legally. Bob Rindfuss