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Old 08-06-2020, 01:40 PM
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Depreciation Recapture With Modified Loan

I'm considering selling my house just to get it off my hands, but I fear the depreciation might make it costly to do so. Here's the situation (I'm rounding numbers to make things easier):
1. I bought the house in 2004 for $180,000.
2. I claimed depreciation on a portion for business use of home. However, part of the deduction couldn't be applied and carried over to the next year (and next). It's still carrying over, even though it went out of business use in 2012.
3. Since 2012, I've been renting it out and depreciating it.
4. Due to a foreclosure battle, I ended up modifying the loan with a principal balance of $270,000.
5. I'm looking to sell just to get this "cursed" property off my hands. I'll probably break even. I currently still owe $265,000 and will probably sell for close to that. So, I won't make any profit.

So my questions are:

A. If I sell it, is my basis for determining profit based on the modified amount ($270,000) or the original amount ($180,000)?
B. If I don't actually make money ~now~ am I still having to recapture all the depreciation?
C. If so, would I be selling as a wash, to ultimately incur thousands of dollars in recaptured depreciation, i.e., am I effectively forced to keep the house, so I don't get hit with a huge tax bill?



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Old 08-07-2020, 07:56 AM
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I'm considering selling my house just to get it off my hands, but I fear the depreciation might make it costly to do so. Here's the situation (I'm rounding numbers to make things easier):
1. I bought the house in 2004 for $180,000.
2. I claimed depreciation on a portion for business use of home. However, part of the deduction couldn't be applied and carried over to the next year (and next). It's still carrying over, even though it went out of business use in 2012.========>however, Note that depreciation is not a factor if you use the simplified method to determine your home office deduction
3. Since 2012, I've been renting it out and depreciating it.
4. Due to a foreclosure battle, I ended up modifying the loan with a principal balance of $270,000.
5. I'm looking to sell just to get this "cursed" property off my hands. I'll probably break even. I currently still owe $265,000 and will probably sell for close to that. So, I won't make any profit.

So my questions are:

A. If I sell it, is my basis for determining profit based on the modified amount ($270,000) or the original amount ($180,000)?=======I guess it is $180K, your original purchase price in 2004 , since the biz use of home is NOT disposed of yet.

B. If I don't actually make money ~now~ am I still having to recapture all the depreciation?========>>No. as you can see, Depreciation is recaptured at the time of the biz use of home, whether you took the depreciation or not. There is no depreciation to recapture if a loss is realized on the sale of the biz use homeas mentioned previously; unless when the sale price of an asset exceeds the tax basis or adjusted cost basis




C. If so, would I be selling as a wash, to ultimately incur thousands of dollars in recaptured depreciation, i.e., am I effectively forced to keep the house, so I don't get hit with a huge tax bill?===========>>as mentioned previously. (Unless you take a loss)when the sale price of an asset exceeds the tax basis or adjusted cost basis. The difference between these figures is thus "recaptured" by reporting it as ordinary income



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Old 08-07-2020, 02:41 PM
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Hi and thank you for your reply. I did have a followup question(s), related to "B" from my original post:

If the cost basis is indeed 180,000, as you answered in "A", and I sold it for $265,000 (which is also the modified payoff amount), then although I'm not making money ~now~, wouldn't the IRS consider it an 85,000 profit with respect to the 180,000 cost basis?

And if I took, say 9,000 in business depreciation in total and then later took 36,000 in rental depreciation (over the course of 8 years), then wouldn't I use that to reduce the cost basis further? Thus, would the IRS consider my profit as 130,000, i.e., 265,000 - (180,000 - 9,000 - 36,000)?

If so, would I be taxed on 130,000 of capital gains income, even though I don't get a dime in my bank account now, since I owe 265,000 on the modified loan? If that is indeed the case, then I really couldn't afford to sell.

Sorry for all the questions; I really don't understand how recapture works and am calculating based on what I've read about it online.

Thanks!



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Old 08-08-2020, 07:18 AM
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If the cost basis is indeed 180,000, as you answered in "A", and I sold it for $265,000 (which is also the modified payoff amount), then although I'm not making money ~now~, wouldn't the IRS consider it an 85,000 profit with respect to the 180,000 cost basis?========>>Asfaras I know, , modified loan amt is not added to your cost basis of the biz use of home. For example, biz use of home cost basis is reduced depreciation allowed or allowable since you used part of your home for business or rental purposes or etc.


And if I took, say 9,000 in business depreciation in total and then later took 36,000 in rental depreciation (over the course of 8 years), then wouldn't I use that to reduce the cost basis further? Thus, would the IRS consider my profit as 130,000, i.e., 265,000 - (180,000 - 9,000 - 36,000)?=====>>>your adjusted basis of the home is 135k, 180k-9k-36k; as said, Your tax break is subject to a ?recapture? restriction, which is designed to prevent a double benefit. You forfeit any exclusion for the part of the profit equal to any depreciation deductions allowed or allowable on the iz use of home after May 1997. Instead, you pay taxes on that part. Allowed or allowable means what you claimed previously or if you claimed less than you could have claimed then the allowable amount is what you could have claimed.i mean, you can't accept tax deductions for biz use of home every year and then also accept residential benefits on that same space when you decide to sell. The IRS "recaptures" those deductions, or depreciation write-offs, that enabled you to reduce your tax liability in the years before you sold your home.


If so, would I be taxed on 130,000 of capital gains income, even though I don't get a dime in my bank account now, since I owe 265,000 on the modified loan? If that is indeed the case, then I really couldn't afford to sell.=======>>as said above, no.modified loan amt is not capital gain. In general, if you have cancellation of debt income because your debt is canceled, forgiven, or discharged for less than the amount you must pay, the amount of the canceled debt is taxable and you must report the canceled debt on your tax return for the year the cancellation occurs.



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Old 08-08-2020, 09:27 AM
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I'm not as worried about the biz recapture (9K) as I am the rental recapture (36K). As it turns out due to limitations, I never actually took the biz depreciation...it's been carried over each year without ever being applied to any income.

Please forgive me, but I'm still having a great deal of trouble deciphering the answer to my question. Would it be possible to give a best-guess, numeric answer to the following criteria?

1. Home purchased for 180,000 in 2004.
2. Home used partially for business from 2004-2012, but the 9,000 in depreciation was never applied to income. Every dime ends up in the "carryover" section of form 8829 indefinitely.
3. Home fully rented from 2012-2020 with a total depreciation applied of 36,000.
4. After 8-year foreclosure battle, during which time no mortgage payments were made, the bank modified the loan to $270,000 (principal balance + missed payments). No debt was forgiven or erased.
5. Now theoretically, I sell for exactly what I currently owe (265,000), and thus don't get any tangible income.

How much of that 265,000 sale would the IRS consider as taxable profit?



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Old 08-09-2020, 03:44 AM
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I'm not as worried about the biz recapture (9K) as I am the rental recapture (36K). As it turns out due to limitations, I never actually took the biz depreciation...it's been carried over each year without ever being applied to any income.===================right.as mentioned below.once you have more expenses than you can claim on f 8829, then, you can carry over the excess to next year(s) and claim it next year(s). I mean you cannot take your biz use of home deduction if it would cause your biz to operate at a loss. You can deduct biz use of home expenses up to your net income (revenues minus other expenses) and carry over the rest to the following year(s).
Please forgive me, but I'm still having a great deal of trouble deciphering the answer to my question. Would it be possible to give a best-guess, numeric answer to the following criteria?

1. Home purchased for 180,000 in 2004.
2. Home used partially for business from 2004-2012, but the 9,000 in depreciation was never applied to income. Every dime ends up in the "carryover" section of form 8829 indefinitely.==================?I guess you mean; as you know, you may only claim a home office deduction up to the amount of net profit from your home biz, a net loss may not be created by claiming the home office deduction.say, you use the actual expense method, and the depreciation of $9K disallowed because of the income limitation at that time, so, you may carry the disallowed expenses over to the following year and treat them as home office expenses of that year.
The carryover expenses plus the actual expenses in the carryover year are also subject to the income limitation.
For example, say, 2004 tentative profit was $2K and your home office expense was $11K(incl $9K of dpr.), then, only $2K may be claimed in 2004. The remaining $9K may be carried over to next year(s) and treated as home office expense for that year.





3. Home fully rented from 2012-2020 with a total depreciation applied of 36,000.
4. After 8-year foreclosure battle, during which time no mortgage payments were made, the bank modified the loan to $270,000 (principal balance + missed payments). No debt was forgiven or erased.=========?in this case, in my opinion, I am not sure if this is your situation, however, it depends o n the situation, Say, If the interest rate on the loan is reduced to a rate that equals or exceeds the "applicable federal rate" of interest, and if the loan is not publicly-traded, generally neither the lender nor the borrower will realize gain or cancellation of indebtedness income. On the other hand, if the interest rate on a non-publicly-traded loan is reduced to a rate lower than the "applicable federal rate," you, the borrower, will generally recognize "phantom" cancellation of indebtedness income on your return.
The most draconian tax consequences, however, are reserved for modification of a loan in which the lender's basis in the loan is less than the unpaid principal balance of the loan. This could result, for example, if the loan was previously purchased at a discount by the current lender, or if the lender had previously taken a partial bad debt deduction with respect to the loan which only certain taxpayers are allowed to do. In these situations, the lender is the party generally at risk for potentially substantial and surprising tax consequences resulting from a significant modification of the loan. For example, say, a loan in the original principal amount of $2million was purchased for $1million, at a time when the entire $2 million obligation remained unpaid. Further assume that the lender and the borrower subsequently modify the terms of the loan in a manner in which a "significant" modification is made. In such a case, the lender will incur $1 million of "phantom" gain from the deemed exchange of the "new" modified debt for the "old" unmodified debt. I guess you need to contact the lender for sure.





5. Now theoretically, I sell for exactly what I currently owe (265,000), and thus don't get any tangible income.

How much of that 265,000 sale would the IRS consider as taxable profit=============?as mentioned above it depends a how the modified loan was treated. I guess you need to contact a CPA/ anIRS EA in your local area for sure .



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Old 08-09-2020, 08:14 AM
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Thank you for clarifying your points.

As for my modified loan, it was all in-house and not publicly traded. The interest rate was reduced, but still higher than the applicable Federal rate (7.250% to 4.125%). No payments or debt were forgiven. So, it doesn't sound like anyone would have received a phantom gain.

I don't know if this would make a difference, but the original loan was bought a couple of times by different lenders well BEFORE the modification was offered, so they might have received a phantom gain then, but not necessarily for the modification. And it was sold again well AFTER the permanent modification was approved. But in neither case did I benefit at all.

So, would you think my cost basis (not considering depreciation) would be the original (180,000) or modified (270,000) loan amount?

Thank you again for all your help. I really appreciate it.



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Old 08-09-2020, 10:01 PM
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I don't know if this would make a difference, but the original loan was bought a couple of times by different lenders well BEFORE the modification was offered, so they might have received a phantom gain then, but not necessarily for the modification. And it was sold again well AFTER the permanent modification was approved. But in neither case did I benefit at all========> sorry I don't know much about the loan modification process. You may contact loan experts fromore info in detail.


So, would you think my cost basis (not considering depreciation) would be the original (180,000) or modified (270,000) loan amount?=====> Refinancing/ loan modificaton never changes your cost basis.
So I n my opinion,
the cost basis of your home is $180K.you may contact tax experts in you r local area for more info or for sure.




also, according to the reference to depreciation ?allowed or allowable? for purposes of determining gain / loss from the disposition of property,the cost basis of the property must be reduced by the amount of depreciation allowed you or, if greater, the depreciation that was allowable to you, so that the basis in the property is reduced by the depreciation you could have elected to take even if you in fact did not actually claim the depreciation deduction.



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Old 08-09-2020, 11:50 PM
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Quote:
Originally Posted by thumei View Post

I don't know if this would make a difference, but the original loan was bought a couple of times by different lenders well BEFORE the modification was offered, so they might have received a phantom gain then, but not necessarily for the modification. And it was sold again well AFTER the permanent modification was approved. But in neither case did I benefit at all.

.
in general, debt restructuring including modification of loan or etc can trigger unforeseen tax consequences. A significant modification of a debt may result in the modification?s being treated as a deemed exchange.
one of the 5 general rules for determining whether a modification is significant. If none of the specific rules apply in a particular situation, the general rule is used to make the determination.
If a significant modification of a debt has occurred, an adviser should analyze the tax consequences to the borrower and the debt holder of the deemed exchange. In determining the consequences, a key point is whether the debt is publicly traded or not.



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Old 08-10-2020, 03:57 PM
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Understood. Sounds like I might be hurting myself if I try to sell the house, unless I can get enough to cover the tax consequences. Thank you for all your help.



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