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Old 10-08-2011, 10:23 AM
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AMT implications of depreciation (short and longer-term)

I converted a property to become a rental property at the beginning of 2011 and am trying to figure out which method (MACRS vs. ADS) will be best for claiming depreciation to optimize tax impact? Here's the situation:

This rental property is my only passive activity and my AGI is too high to deduct in any given year. But, I understand that the passive loss will convert on the sale of the property to active and be used to offset either capital gains on the sale or active income. What I'm having problems with is understanding how AMT might impact this (I typically have at least a small AMT obligation each year)? Would the gain in the year of sale (esp. if offsetting active income) be affected by AMT? In the years prior to sale, it seems like higher depreciation (using MACRS) might increase my tax obligation because of AMT?

So which method is most likely to be the best choice? MACRS to maximize carryover passive losses that can be converted to offset active income (or capital gains) in the year of sale? Or ADS because AMT is likely to screw up the first scenario in addition to the potential AMT implications in every year between now and sale?

Thanks in advance.



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Old 10-08-2011, 10:31 AM
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One more thing...

I forgot to mention that the depreciation expense is unnecessary in each year to offset potential rental income. Even without taking the depreciation into account the property will generate a small loss each year. So I get zero benefit from the depreciation expense.



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Old 10-08-2011, 09:46 PM
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“This rental property is my only passive activity and my AGI is too high to deduct in any given year. But, I understand that the passive loss will convert on the sale of the property to active and be used to offset either capital gains on the sale or active income.”---->Correct; the IRS, in general,views the income from your rental property as passive income and applies special passive activity loss rules to that income; as a passive participant, Your rental losses(suspended losses) build-up from year-to-year until you have rental income to offset the losses or you sell the property. When you sell the property, you can write-off all unused rental losses. So, When you sell your passive rental property, you can use the suspended passive losses from earlier years to offset the gain generated by the sale( I mean including the gain subject to unrecaptured depreciation on your rental property----25% rate andsec 1231 Gain(LTCG)). If the suspended loss allocated to that property is greater than the gain on sale( perhaps LTCG), the entire suspended loss allocated to that property may be deducted. It’s deductible regardless of whether there is a net overall suspended loss for the property. If the gain on sale of the property is in excess of the suspended loss allocated to the property, losses allocated to other passive losses( if you have).Because your gain is treated as passive activity income and is therefore available to offset other passive losses. If you take the loss, then the loss from the sale of the property is not a passive loss. If you have a passive loss from this year or suspended passive losses from prior years related to this property, they can be deducted in the year in which the property is totally disposed of. These losses would offset any gain you may have realized from the sale. If losses exceed gain, they may be deducted.
“What I'm having problems with is understanding how AMT might impact this (I typically have at least a small AMT obligation each year)?---->Due to a passive activity, one of every seven taxpayers subject to the AMT. A disposition of your passive activity losses may result in a favorable AMT adjustment. Because depreciation deductions may be greater for regular tax than AMT, the gain and PAL adjustments are mirror images. If none of the regular passive losses have been used prior to the year of disposition, the net gain/loss and passive loss should be the same for regular and AMT(although the gain/loss may be section 1231 and the PALs will typically be ordinary character). You need to be vigilant that the tax return software picks up the usually favorable AMT adjustment on the gain/loss calculation as well as the usually unfavorable adjustment to the PAL. If some of the regular PALs have been used, the net result of the disposition may be to reduce AMTI compared to regular taxable income.So as you claim deductions for depreciation, you must adjust those deductions in computing AMT income to the amount of deduction allowed for AMT. For AMT purposes, depreciation is computed on most assets under the straight line method using the class life of the asset. When you are required to recognize gain or loss on disposal of a depreciable asset, the gain or loss must be adjusted to reflect the AMT depreciation amount rather than regular depreciation amounts.
“ Would the gain in the year of sale (esp. if offsetting active income) be affected by AMT?”---->As said above. The deduction for net operating losses, is adjusted to be based on losses for AMTI. Net operating loss deduction( assume that PAL is included in NOL), from Form 1040, line 21 is reported on Form 6251 line 10.
“ In the years prior to sale, it seems like higher depreciation (using MACRS) might increase my tax obligation because of AMT?”---->I guess it depends on your situation;AMT requires that rental property placed in service between 1987 and 1998 be recovered using S/L depre. over 40 years.So, as long as you, instead of using ADS, elect under MACRS to depreciate your rental property over 27.5 years over 40 years under ADS, the difference in the two methods is your AMT adjustment( you need to report the difference on Form 6251 line 18). However, there is no AMT depre. Adjustment for rental property placed in service after 1998.
“So which method is most likely to be the best choice? MACRS to maximize carryover passive losses that can be converted to offset active income (or capital gains) in the year of sale? Or ADS because AMT is likely to screw up the first scenario in addition to the potential AMT implications in every year between now and sale?”---->As said above; there is no AMT depre. adjustment on Form 6251 for rental property placed in service after 1998. You generally must use MACRS (GDS) unless you are specifically required by law to use ADS or you elect to use ADS. As said, as long as you placed your rental property in service between 1987 and 1998, MACRS depreciating your rental property over 27.5 in lieu of 40 years using S/L can cause difference the AMT adjustment.



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Old 10-08-2011, 10:46 PM
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Thanks!

Thanks! It's probably going to take me a few more reads to make sure I understand all that properly, but it seems to me that MACRS is likely to be best since there is no impact from AMT each year (placed in service after 1998), and the carryover loss will be useful in the year of sale against any gains on the sale and, after that, active income.



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Old 10-09-2011, 12:51 AM
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" MACRS is likely to be best since there is no impact from AMT each year (placed in service after 1998),"----->Correct; your use of either the MACRS,( General Depreciation System )or the Alternative Depreciation System to depreciate you rental property under MACRS determines what depreciation method and recovery period you use. You generally must use MACRS unless you are specifically required by law to use ADS or you elect to use ADS; the IRS generally allows you to depreciate the value of the structure on the rental property over a period of 27.5 years. This is the logical treatment of the fact that buildings do wear out over time, or become obsolete due to their older features no longer in demand. However, to use ADS , the property must BE: listed property used 50% or less in a qualified business use; any tangible property used predominantly outside the United States during the year; any tax-exempt use property.
and the carryover loss will be useful in the year of sale against any gains on the sale and, after that, active income."-->Correct; so as long as your suspended NOL(PAL) exceeds the whole amount of gain(LTCG/ ordinary gain subject to 25% depre.recap rule) on the sale of the rental property, then you are NOT even subject to 25% depre recap rule. However, susupended Net operating loss deduction( I mean suspended PAL as said above), from Form 1040, line 21 is reported on Form 6251 line 10.



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