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taxmanrog
taxmanrog, Certified Public Accountant (CPA)
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Experience:  Licensed CPA, MA, MST with 29 year's experience. Teach Accounting and Tax courses at Masters level.
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I inherited a house in 1991 and used it as a rental after residing

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I inherited a house in 1991 and used it as a rental after residing in it for several years. I did not take depreciation because I intended to sell but the market fell forcing me to hold out until prices rebounded. Upon sale today (2013) I am advised I will owe capital gains on the entire sales amount by real estate lawyer and a CPA. I cannot accept this opinion. What is the true status of my tax liability?
Submitted: 1 year ago.
Category: Tax
Expert:  taxmanrog replied 1 year ago.

Welcome to Just Answers! Thank you for giving me the opportunity to assist you! I will do my best to help!

 

Why do they say you will owe capital gains on the entire sales amount? That is not correct! Even if you had used it as rental property from the beginning, you would have had to have used MACRS depreciation, which depreciates a residential property over 27.5 years. So it would not be fully depreciated until sometime in 2018 or 2019.

 

Your basis for depreciation would be the FMV at the date you inherited the property back in 1991. You would calculate depreciation only for the period of time that it was rented out. So if you used it as your residence for several years, depreciation does not apply to these years.

 

Unfortunately, whether or not you actually claim depreciation while it was rented does not matter. The Internal Revenue Code is clear - it is depreciation "allowed or allowable". So even if you don't deduct the depreciation, but you could have, you have to reduce your basis by the amount that would have been deducted. Land is not depreciated, so you should separate the FMV when you inherited the property into the land and the building, and only the building gets depreciated.

 

You will pay tax only on your gain. The gain is the difference between the sales price and the basis. The basis is the FMV at the date you inherited the property, plus the costs of any improvements you made (roof, windows, furnace, A/C, carpet, etc) minus the depreciation for the periods that it was rented. So, for example, if the property was worth $150k when you inherited it, and $30k was land and $120k was building, and you rented it out for 12 of the 21 years you owned it, your depreciation would be $52,364 ($120k/27.5 * 12), so your basis would be $30k + $120k - $52.4k, or $97,636. If you sold it for $200,000, your gain would be $102,364. Any improvements you made would increase this basis. You would only pay tax on this gain.

 

I hope this has answered your question! If you have any more, please feel free to ask! If you have found my answer helpful, please rate me highly. I would appreciate that!

 

Again, thanks! Have a great week!

 

Roger

taxmanrog, Certified Public Accountant (CPA)
Category: Tax
Satisfied Customers: 423
Experience: Licensed CPA, MA, MST with 29 year's experience. Teach Accounting and Tax courses at Masters level.
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