|   Dear
Tax Talk,
I'm trying to figure the cost basis for a rental house that
my wife and I bought in mid-November in partnership with another couple. We bought
it on the courthouse steps for $81,000 when the second mortgage holder foreclosed.
There was also about $125,000 owing on the first mortgage; about $100,000 principal
and $25,000 accrued interest and penalties. We paid off the interest and penalties,
and made one regular monthly principal and interest payment in December. We also
received rental income from the tenants in December.
In January we refinanced the house and paid off the
holder of the original first mortgage. The fair market value was
appraised by our bank in January at $270,000. What is the cost basis
we should use? Is it what we paid on the courthouse steps ($81,000)
plus the acquired debt to the first mortgagor ($125,000)? Or is
only what we paid out in cash ($81,000 to the second plus $25,000
to the first)? Or maybe it's only $81,000, and we should deduct
the interest and penalties of $25,000 that we paid in December?
As you can see, I'm very confused about this transaction. We've
always done our own taxes, but this one has me stumped!
Thank you so much for your advice. I've been
working my way through all your archived answers and they are very,
very helpful.
-- Damian
 Dear
Damian,
Bankrate's archives are a great source of information,
but in this case it's certainly not your traditional purchase, so I can understand
your confusion.
Your cost is what you paid for the property plus the
amount of debt you assumed in the purchase. You cannot deduct the
interest and penalties that you paid to the first mortgage holder
since this was not your debt at the time the interest accrued. However,
you have to include the $125,000 as part of your cost since this
was a debt that you assumed. It would be the same if you were to
go out and buy a house for $100,000 with $20,000 down. Your cost
in that case would be $100,000, not the $20,000 that you paid.
So based on what you described, your cost should be
$206,000, which includes the original $81,000 plus the assumed debt
of $125,000. The interest portion of your December payment would
be your deduction since you owned the home at that time. The rent
you received would also be your income. The refinancing does not
affect the cost of the property, but any expenses associated with
it should be amortized over the life of the new loan.
Since you own the property jointly with another couple,
each of you should report one-half of the property on Schedule E
of your Form 1040. You would use one-half of $206,000 to claim depreciation
on the property. Of course, you have to deduct from the depreciable
cost the amount allocable to land, which is not depreciable.
[NOTE TO READERS: I appreciate all the questions
you send each week. But because of the volume, you may not have
the answer you need before the filing deadline of April 15. If you
haven't heard back from me and you really need an answer before
you can file, check out the full Bankrate
Taxes site, especially my previous
columns and the Tax
Tool Box. What you need may be there. If not, consider seeking
an extension
of time to file your federal and state returns so you'll have
time to get the tax answer you need. But remember: If you do get
an extension, be sure to pay now what you might owe to avoid interest
and penalties.]
|
