COMPUTING YOUR GAIN
ON SALE OF REAL ESTATE.
For sales of real estate property these are the main factors that we need to know in order to compute the gain:
1) The fair market value of the property.
2) The capital gain tax rates.
3) The taxpayer's marginal tax bracket.
4) The adjusted "tax basis" of the property.
5) Date of purchase and date of sale.
Number 1, 2 and 3 are not that difficult to determine. But the adjusted tax basis is sometimes difficult to obtain.
Our experience is that there are a lot of mistakes made in this area. The information that we need may be decades old.
The client might have changed accountants several times, and not all accountants maintain the historical data needed
to compute adjusted tax basis correctly.
What is "adjusted tax basis"?
Adjusted tax basis is an accounting equation and is determined as follows:
Original purchase price
+ Transaction costs
(Escrow fees, title documentation, etc.)
- Depreciation
+ Improvements
= Adjusted tax basis
Adjusted tax basis, under the Internal Revenue Code (I.R.C.), is the amount that you deduct from the adjusted sales price
of the real estate unit sold to arrive at your gain. I.R.C. Sections 1001; 1011; and 1012.
Depreciation is taken based on lives determined by the Internal Revenue Service and as improvements
are added those are depreciated from the date in which they are added on, with a life independent
from the original purchase. I.R.C. Sections 167, 168.
Example 1:
You purchased a house in 1996 as a rental investment for $184,000. Your closing costs were $2,438.
Your total original basis is $186,438.
Now you must apportion the basis between land and building.
From the assessor's records you can see that it is apportioned 34% land 66% building. This apportionment may be accepted,
but if there is a more objective source for the apportionment you should use that.
The depreciable portion then is $123,050. You take straight line depreciation for 27.5 years.
Subsequently you add carpeting, flooring, appliances, and the pool is refurbished.
By 2004 the house is valued at $450,000. (We will ignore selling costs to simplify the computation).
Your adjusted tax basis would be:
|
Land
|
$ 63,388
|
66% Total
|
|
Building
|
123,050
|
34% -----} $186,438
|
|
Plus Improvements
|
9,388
|
|
Total investment
|
$195,826
|
|
Depreciation
|
(35,225)
|
|
Adjusted basis
|
$160,601
|
Your taxable gain would be:
|
Selling price
|
$450,000
|
|
|
Adjusted basis
|
(160,601)
|
|
Total gain
|
$289,399
|
But first, the amount of depreciation that was taken before must be recaptured as "ordinary income"
at a maximum rate of 25%. the balance is the capital gain subject to the preferential rates of 5% or 15%,
depending on the taxpayer's marginal tax bracket.
The allocation then would be as follows:
|
Capital gain
|
$254,174
|
(at 5% or 15% tax rate).
|
|
Ordinary income
|
35,225
|
(up to 25% tax rate).
|
|
Total gain
|
$289,399
|
If this is your residense, you might have a $250,000 gain exclusion for you and $250,000 for your spouse,
if you are married, considering that you qualify
As you can see, there are many factors to consider, so, before you put any real estate property for sale,
you should consult with a tax expert.
|
