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A property I own is a single family house that I once resided

in, then rented for a...
A property I own is a single family house that I once resided in, then rented for a few years. Now it is vacant and technically up for sale, but failed to sell (yes, even in the bay area market). I have decided to try an “owner will carry” sale largely to avoid capital gains and need to know how best to handle taxes as related to this situation.
During my residency of 12 years, I spent maybe as much as 100K in improvements. In the last few weeks I have spent about 20K preparing it to sell. The tax consultant that I’ve had for many years did figure capital gains on the projected sale of my house. She seemed to think that none of the improvements that I made on the home during residency could be written off because I had eventually rented it. This was shocking, I had always been led to believe that improvements made to the house would figure into all this to my benefit.
She talked about depreciation recapture. I read an article on this and still have absolutely no idea what it is or how it relates to my situation. The capital gains that she figured was over 30%. I did not understand what she was talking about and have a hard time believing that more than 30% would be taken out. It makes it not worthwhile to sell the house at all.
I am trying to sell on an “owner will carry” to avoid some of the tax but she did not seem to know much about how that would work. I've read about an installment sale which ostensibly would avoid tax with owner financing but I didn't understand how this works either. I am hoping to get a second opinion, one that I can understand and helps me to know what to do.
Lastly, it's come to my attention that it's possible to get a medical exemption on capitol gains when selling a house. The reason for the sale is largely due to medical necessity. I retired a year and a half ago due to a work accident that resulted in a spinal injury that has left me semi-invalid and unable to work. My income decreased significantly. The medical situation is deteriorating so I have moved into an inherited home because it is invalid friendly and affordable. Unlike the house I'm selling, it is on much more level ground and has bedrooms on the first floor, one of which has an ADA bathroom with grab bars, shower seats and raised toilet. Someone is moving in to be my caregiver. I’m sure that my physician would be willing to write a letter to confirm my disability. I would need to know specifically what language needs to go in the letter and how to go about doing this. Also, is this something that I should get pre approved by the IRS?
Thank you,
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Answered in 1 hour by:
5/21/2015
Lev
Lev, Tax Advisor
Category: Tax
Satisfied Customers: 30,330
Experience: Taxes, Immigration, Labor Relations
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Hi and welcome to our site!
Several issues...
1.
First of all - we need to separate repairs and improvements.
See page 12 in this publication
http://www.irs.gov/pub/irs-pdf/p523.pdf
Improvements
These add to the value of your home, prolong its useful life, or adapt it to new uses. You add the cost of additions and improvements to the basis of your property.
I hope that reference will help to convince your tax consultant.
2.
When you rented the property - you deducted depreciation - correct?
Depreciation is an income tax deduction that allows a taxpayer to recover the cost or other basis of certain property. It is an annual allowance for the wear and tear, deterioration, or obsolescence of the property.
So when the property is sold and if there is a gain - a part of that gain is attributed to the depreciation recapture - means that amount previously deducted is added back to your income.
3.
That is correct - the sale transaction is reported in the year of sale.
However - when sold on installments - a part of payments is allocated to interest - which is taxed as interest income in the year received.
.
Under the installment method, you include in income each year only part of the gain you receive, or are considered to have received. Use Form 6252 (PDF), Installment Sale Income, to report an installment sale in the year the sale occurs and for each year you receive an installment payment. You will need to file Form 1040 (PDF), U.S. Individual Income Tax Return, and may need to attach Form 4797 (PDF) and Form 1040, Schedule D (PDF).
You report interest on an installment sale as ordinary income in the same manner as any other interest income. If the installment sales contract does not provide for adequate stated interest, part of the stated principal may be recharacterized as "imputed" interest or as interest under the original issue discount rules, even if you have a loss. You must use the applicable federal rate (AFR) to figure the unstated interest on the sale. The rates are published monthly in the Internal Revenue Bulletins on IRS.gov.
See this:
http://www.irs.gov/taxtopics/tc705.html
4.
Regarding "medical exemption" ...
That may be used when the main home is sold and you owned or lived in the home less than two years.
If you rented your home less than three years - you might qualify for the exclusion without any exemption.
.
When you are selling rental property - that exemption may not be used.
For details - see page 4
Does Your Home Qualify—Details and Exceptions
Partial Exclusion May Be Available
http://www.irs.gov/pub/irs-pdf/p523.pdf
Health-related move. You meet the standard requirements if any of the following happened during the time you owned and lived in the home you sold:
Let me know if you need any help.
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Customer reply replied 2 years ago
Hi Lev, Terrific answers. I think I actually beginning to understand most of it. After reading publication 523 it looks to me like I could possible qualify for at least a partial medical exclusion. After living there for 12 years, I moved in 2009 due to the medical condition and then rented it out for less than 6 years. I had to wait for housing prices to come up. Do you think I have a chance with this?Assuming that depreciation has been deducted each year I rented, is this what is elevating my capital gains tax over 30%? (I'm single)Here's a new subject. The house I live in now is shared 50% with a relative who does not reside there. Since moving in, I have paid all taxes, insurance, upkeep, and I pay her rent. It is a pre-prop13 property and I always want to keep her name on the lease to keep property taxes down. Could I use 1031 with the proceeds of the sale of my other house to purchase a portion of her share of the property, still keeping her name on the lease and avoid loosing the pre prop 13 status? It is definitely a similar house.Lastly, I don't know where you are located, but I'm having trouble finding a tax consultant in the San Jose, CA area that specializes enough in capital gains to handle my taxes, specifically the installment sale. Obviously, the proper forms would need to be filed each year. Could you either recommend someone or do you have any suggestions how to find someone?Thank you, Susan
Hi Susan
1.
Unfortunately that "partial medical exclusion" may not be used.
Even if you qualify - that exclusion is based on the time the property was used as a primary residence during last five years.
Because during last five years - your had zero days as a primary residence - there would be nothing to exclude.
So - there would not be any sense to discuss if you qualify or not.
2.
Depreciation - allowed or allowable - will reduce the basis. So the amount of depreciation is subtracted from the basis.
Correspondingly - the gain will be increased by that amount because the gain is calculated as
(selling price) MINUS (adjusted basis)
That gain is added to your other taxable income but taxed at reduced rate as long term capital gain - in most situations - not more that 15% plus state income taxes.
3.
You may use proceeds from the sale to purchase another property - under section 1031 like-kind exchange.
That will allow to defer (not avoid!) the taxable gain.
However - that should be another rental property - and may NOT be a property that is used for personal purposes.
ONLY the business or investment property may be used under section 1031.
4.
Unfortunately - I may not provide any specific recommendations.
However - I do not see anything complicated in your issue and any tax preparation service could be helpful.
See here some recommendation regardless selecting CPA
http://www.dca.ca.gov/cba/consumers/slectcpa.shtml
Let me know if you need any help.
Lev
Lev, Tax Advisor
Category: Tax
Satisfied Customers: 30,330
Experience: Taxes, Immigration, Labor Relations
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