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Old 07-31-2011, 09:23 AM
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Basis of rental property

Can somebody please help me with this scenario. I had a primary residence that i convented into a rental. I understand that i will be losing the home sale exclusion. however, was just curious what the basis would be? Also, to minimize my tax liability at the sale of the investment property, could i take out a line of credit against the property (lowering my basis). I didn't want to do a like kind exchange cause i want out all together? Any suggestions. Thanks.



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Old 07-31-2011, 09:48 PM
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“ I had a primary residence that i convented into a rental. I understand that i will be losing the home sale exclusion.”--->Correct. You may decide to permanently convert your personal residence to rental property. The decision is ALSO made as a result of your inability to sell the property at a gain or a desire to retain the property for future personal use. (If the residence would be sold at a gain, the ability to exclude up to $250,000 of gain ($500,000 on a joint return) under Sec. 121 may make the conversion option less attractive.). What I mean is that if selling a personal residence would result in a nondeductible loss, then you need to convert the residence to rental property since any loss realized while the home is a personal residence is never deductible.
“ however, was just curious what the basis would be?”--> The basis would be the fair market value at the time of conversion, or whatever you paid for it plus improvements, whichever is LESS. The principal issue when converting from personal residence to rental is your basis in the property for depreciation purposes. The amount of the outstanding mortgage is irrelevant. You must depreciate rental property since the depreciation is subject to recapture at sale time even if you don't take it while you hold the property for rental. When you dispose of the rental property, a special 25% tax rate applies to real property gains attributable to depreciation previously taken ( while the property is used as rental property) and not already recaptured under the section 1250 rules. Any remaining gain attributable to unrecaptured depreciation previously taken, including straight line depreciation under MACRS rules, is taxed at 25% rather than long term CG rate of 0%(if your tax bracket is 15% or lower) or of 15%(if your tax bracket is higher than 15%). When your ordinary tax rate is only 10 or 15%, the depreciation recapture will be taxed at 10 or 15% to the extent of the remaining amount in the 10 or 15% bracket and then at 25%. The IRS may not question your depreciation deductions year in and year out but they can still challenge what should have been *allowable* depreciation 27.5 years down the road when you sell. If you move back into the property and it is your full time residence, then you would accumulate the depreciation taken as said previously and upon sale of the property, you would recapture any depreciation as ordinary income. This would have to do with the sale if you met the 2 out of 5 year rule to qualify for the section 212 exclusion in the future, I mean.
“ Also, to minimize my tax liability at the sale of the investment property, could i take out a line of credit against the property (lowering my basis). I didn't want to do a like kind exchange cause i want out all together?”---> Your basis is essentially your investment in an asset—the amount you will use to determine your profit or loss when you sell it. The higher(LOWER) your basis, the less(MORE) gain there is to be taxed—and therefore, the lower(HIGHER) your tax bill. This is why it's so important to accurately track the basis of any investment you own. Many homeowners have a home equity loan or line of credit but don't know the best way to use it. Using home equity can be smart in certain circumstances, and not so smart in others. it's wise to use caution when using a home equity loan or line of credit, given that: Like any loan, you'll pay fees and interest.Your rental home is collateral for the loan, so if you default on the loan, you could lose your rental home.By its very nature, a home equity loan depletes equity in your rental home.



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Old 07-31-2011, 10:47 PM
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hey thanks man, will take this into consideration. Thanks for all your help, I just signed up today and I am so thankful for this blog. It is so hard to find stuff on the internet regarding tough tax issues. By the way, could you take a look at my extreme coupons thread. Thanks for all you help again.



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Old 11-15-2011, 11:47 AM
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Will the IRS accept the county property tax "Total Land and Improvements" value as the basis at time of conversion from primary to rental? This value has been adjusted and is much lower than my purchased price. I plan to make some improvements due to city code enforcement. If I sell this home in say 6 months to a year after converting to rental, can I claim a loss based on the price I sell and this basis + improvement? Thanks



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Old 11-15-2011, 12:36 PM
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“Will the IRS accept the county property tax "Total Land and Improvements" value as the basis at time of conversion from primary to rental?”---->Yes;I guess so; the adjusted basis is the original cost of the building, excluding the value of the land, plus permanent improvements and other capital costs. When you convert your personal residence to a rental property,you can begin to claim depreciation in the year you converted it to rental property UNDER the MACRS rule as you can see because its use changed to an income producing use at that time. The tax basis of the rental property is is the lower of the Fair Market Value of the property on the date of the change in use OR the adjusted basis of the property.
“This value has been adjusted and is much lower than my purchased price. I plan to make some improvements due to city code enforcement.”--->Then as you can see, you can depreciate the improvememts for the next 27.5 years under the MACRS rule.
“If I sell this home in say 6 months to a year after converting to rental, can I claim a loss based on the price I sell and this basis + improvement?”---->It depends on the sales value.I mean to determine if you have a taxable gain,STCG, or loss,ordinary loss, you will need to compare therental home’s sale price to its tax basis. The tax basis is generally your original purchase price, plus the cost of improvements (not counting expenses you’ve deducted as repairs and maintenance), minus any depreciation deductions you claimed while you owned it. As you dispose of the rental property in 6 months after you convert it into rental home, then the gain’d be STCG, ordinary gain subject to ordinary tax bracket( as you hold the home less than one year). Then you need to recapture unrecaptured real estate depreciation, 25% rate. I assume that you purchased the home converted into rental home after 1986, then the home(now rental home) is NOT subject to Sec 1250 recaptured depreciation rule but it is subject to unrecaptured depreciation on real estate, 25% rate rule. As long as you sell your rental home at a loss, the loss ‘d be ordinary loss offsetting other gains or income.IN this case, you can’t deduct anything as you have no gain. You do not even recapture 25% rate of unrecaptured deprecation on real estate for the six month depreciation.However, that loss will be a Section 1231 loss which can be a good kind of loss to have; section 1231 losses can be used to reduce any type of income you may have ,i.e, salary, bonus, self-employment income, capital gains, you name it; you may have a net operating loss (NOL) if the Section 1231 loss is large enough to reduce your other income below zero. If so, you can carry back the NOL for at least two years and use it to offset taxable income in those years. In doing so, you can recover some or all of the taxes you paid in those previous years by amending those returns. If any of the NOL is left over after going back two years, you can carry the rest forward into future tax years to offset future income (for up to 20 years). Alternatively, you can choose to not to carry it back and just carry it forward for 20 years.



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