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Stephen G.
Stephen G., Sr Income Tax Expert
Category: Tax
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Experience:  Extensive Experience with Tax, Financial & Estate Issues
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Question to "MyVirtualCPA":I have a rental property which I

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Question to "MyVirtualCPA":I have a rental property which I purchased for about $40K in 1978. The property is worth about $150K now and has a $140K mortgage on it (after several cash-out refi's). I recently had to make about $25K in repairs to be able to rent the property again. I don't think I can sell the property without incurring capital gains tax in excess of the equity I have left in it. I'm thinking of donating the prperty to my college to get rid of the tax liability. My question is how much can I deduct from taxes? Am I limited to the $10K equity I am donating, or can I also deduct the $25K in repairs? Can I deduct any of the $11K in carryover expenses from last year? Over what period of time cmust I take the deductions?

Stephen G :

Hi & thanks for using our service. I'll do my best to give you a complete & accurate answer. Please ask me to clarify anything that is not clear.

Stephen G :

Apparently "My Virtual CPA" isn't available to answer your question as it has been opened up to the rest of us.

Stephen G :

First, a couple of comments:

Stephen G :

1. If you were to sell the property, as I'm sure you know, your capital gains would be based upon your original cost, plus any additional improvements, less the accumulated depreciation through the end of the rental period or the date of sale. The "repairs" you mention would either be deductible as rental expenses or capitalized increasing the tax basis, depending upon the composition of the expenses; either way, if you were to sell the property, you would get the benefit of those expenses.

Stephen G :

2. Since the rental property is subject to the mortgage, most likely your college would not be receptive to a gift of the property subject to such a large mortgage, even if the mortgagee would allow that kind of a transfer of the property. If there were substantial equity in the property, the school would be more likely to work something out to get the mortgage paid off.

Stephen G :

3. As far as determining the amount of your charitable contribution, it would be based upon an appraisal of the Fair Market Value at the date of the gift, less any debt assumed by the donee, less any depreciation recaptured as ordinary income (this is likely very small, if any, as it would only amount to the excess of any accelerated depreciation over straight line & given the length of time you owned the property, it is likely that the property may be fully depreciated anyway).

Stephen G :

Unfortunately, every time you converted equity in the property to cash through refinancing, in effect you deferred taxes on that portion of the untaxed gain in the fair market value of the property. Now, you have what is referred to as a "burned out tax shelter", and there isn't any way to avoid the capital gains tax except to hang on to the property and get as close to breakeven cash flow wise as possible by continuing to rent the property.

Stephen G :

Questions?

Stephen G :

?

Customer:

Wow, that is a pretty bleak picture you paint. I'm sure it is fully depreciated now, so if I sell it outright, do you know the ballpark amount of capital gains tax I'll owe on the sale? Would living in it 2 years before selling avoid the tax altogether?

Stephen G :

Well, in 2013 the maximum federal capital gains rate is 20%, but the actual tax could be lower depending upon your other income, deductions, etc. for 2013.

Stephen G :

As far as living in it for 2 years out of 5 ending on the date of sale, you would avoid substantially all of the capital gains tax except possibly for a portion of the depreciation claimed. I'd have to check on the rules re that going back to 1978 and the useful life and depreciation method you used.

Stephen G :

Also, you'd have the CA tax which just adds the gain to your regular income.

Stephen G :

The tax could be as much 40K if the net sales price were 150K. There's no deduction related to the mortgage payoff.

Stephen G :

Could you sell the property under a land contract arrangement whereby you retain title to the property while the purchaser builds up equity in the property?

Customer:

I'm probably going to keep the property for another year as a rental. I expect California real estate to rebound by then so maybe the property will be worth $200K. Would the college be any more receptive to accepting it as a gift even with the $140K mortgage?

Stephen G :

It's hard to say, but clearly more receptive than with only 10K in equity. Several factors would be involved. It sounds like it isn't a property they would want to keep as an investment. Given that, they would most likely sell the property anyway. Sometimes if property is close to a college, they want it for housing or clubs or a variety of other things and thus keep it and use it as part of their exempt purpose.

Stephen G :

You just need to check with the Development Office.

Stephen G :

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