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Author: irasmilo Big gold star, 5000 posts Old School Fool Add to my Favorite Fools Ignore this person (you won't see their posts anymore) Number: of 121219  
Subject: Re: Capital Gains tax Date: 8/12/2004 8:30 AM
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cross-posted from the buying/selling house board...

Related somewhat to my prior questions;

As I couldn't met the June 30 deadline to avail of the capital gains allowance under the 2-year rule, I renewed the lease for another year and am resigned to the fact that I will have to pay capital gains sometime down the road, whether or not I avail of Section 1031.

When I sell, what valuation do I put on the property, if?

I bought it for $150k but when I converted from residential to commercial, the property was deemed to the worth $300k and was taxed and insured at that level.

Similar houses are currently selling in the low $400k's, in an agressive buyers market. Would it be fair to say that the taxable profit on my investment is $100k ($400k - $30k), if I were to sell today?

Could the other $150k of the profit be exempt from capital gains as it is below the $250k threshold as the property was my primary residence for the preceeding 4 (continuous) years?

I'm googling, but offhand does anyone know if there is a precedent?


I'm reading between the lines here (since I don't know what "2 year rule" you are referring to), but I think your situation is the following:

You bought a residential property for $150K. Later you converted the property to rental property. You have owned the property for more than 2 of the last 5 years, but can no longer claim to have lived in the property for more than 2 of the last 5 years, so you don't qualify for the 250K/500K capital gains exclusion. You then want to know how your gain would be calculated and taxed if you were to sell today. If any of these assumptions are wrong, then what I am about to write may be incorrect.

When you converted the property from personal residential use to rental, you needed to determine the cost basis of the property as a rental property. This is the lesser of your adjusted cost basis (150K plus capital improvements) or fair market value (300K). I would assume that your cost basis is the lesser amount.

You then have to begin depreciating the building portion of the property (but not the land component). If you were to sell today for $400K, the following would apply:

You would show a long-term capital gain of $250K ($400K-150K). (I've ignored issues such as selling costs which could reduce the taxable gain.) You would also show a Section 1250 gain equal to the amount of depreciation you've taken or should have taken. This gain would be taxable at a rate equal to your ordinary tax rate, but not to exceed 25%.

Tax can be deferred through the use of a Section 1031 exchange if done correctly. Once you fail the 2 out of 5 year ownership and usage tests, you cannot prorate the capital gains exclusion unless you meet one of the exceptions (job transfer, medical, etc.)

If I've assumed something in error, or something isn't clear, just ask again.

Ira
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