Dear Tax Talk,
We sold a house in April 2010. It was originally our personal residence that we purchased in 1975. In 1980 we converted it to a rental. From 1980 to 1984 we depreciated the house using a 30-year life and 125 percent declining balance depreciation. We read where the excess depreciation over the straight-line amount for 1980 to 1984 must be recaptured as ordinary income. Is that correct?
In 1985, we depreciated the rental over the remaining 25 years of the 30 years’ useful life using the straight-line depreciation method. Our question is: Are we subject to the Section 1250 depreciation recapture on the full amount of the depreciation claimed over the 30-year period? We took the rental house out of service Dec. 31, 2009. In January, February and March 2010 we made improvements to the house and put it on the market and sold it at a gain in April 2010.
What forms do we need to use to report the gain and the Section 1250 depreciation recapture if required? Also, we think we may be liable for alternative minimum tax. How do we determine and calculate that? We also understand that for the years 1980 to 1984 we may have to recapture the excess depreciation over the straight-line rate for those five years — what form do we use for that? Or is the amount of depreciation for 1980 to 1984 just included with the depreciation claimed for 1985 to 2009 for the Section 1250 depreciation recapture? We certainly would appreciate any information that you could share. Thanks.
Your question takes me back in time to when I was a young accountant and we had all these assorted depreciation rules. Depreciation recapture on real property is a specially taxed type of capital gain. Recapture involves taking the prior depreciation deductions back into income, and it occurs at the sale of a property.
You’re right in saying that, back then, you had to recapture the excess of the accelerated depreciation over straight-line as ordinary income. But when a property as in your case is fully depreciated, then there is no excess, as it would have reversed when you wrote off 100 percent of the cost. At one time there would have been an excess as, for example, accelerated depreciation may have resulted in you writing off 40 percent of the cost after 10 years while straight-line would have only resulted in one-third of the cost being written off. This excess was considered ordinary income taxed up to the maximum rate that applied.
Section 1250 depreciation recapture differs in that the maximum tax rate that applies is currently 25 percent. The recapture applies to the full amount of the original cost that you claimed as depreciation. If the house cost you $50,000 and you used $40,000 as your depreciable basis (allocating $10,000 to nondepreciable land), then $40,000 is treated as Section 1250 recapture. Use Form 4797 Part III to report the gain on the sale of the home. Note that line 26 relates to ordinary income recapture and does not apply to your sale. Instead the 1250 recapture is used when applying the tax rates using Schedule D.
Use Form 6251 to figure if you’re subject to alternative minimum tax, or AMT. There are many reasons you may be subject to AMT, one of which may be the favorable rate that applies to the sale of the home. I strongly suggest you use a tax program to figure your tax return as you have many forms to complete by hand otherwise.
Ask the adviser
To ensure compliance with requirements imposed by the IRS, we inform you that any U.S. federal tax advice contained in this communication (including any attachments) is not intended or written to be used, and cannot be used, for the purpose of (i) avoiding penalties under the Internal Revenue Code or (ii) promoting, marketing or recommending to another party any transaction or matter addressed herein. Taxpayers should seek professional advice based on their particular circumstances.