Taxable gain equals selling price less “adjusted basis.” (“AB”). AB is the cost of the property with certain adjustments. AB is reduced by depreciation. So if a taxpayer has depreciated a property for many years, its adjusted basis may be considerably reduced. The gain resulting from depreciation is often called phantom gain and the resulting tax may considerably reduce the cash you receive on the sale. A different problem arises if you have refinanced the property and spent the cash elsewhere. Once you repay the loan upon the sale you will have less cash available to pay taxes.
What do you do? There are many ways to reduce your tax. I look for ways to increase the “adjusted basis.” (“AB”). Each property is a little different and there are many factors that increase AB, so I suggest working with a tax professional. For example, did you know that property that you inherited is treated as if you purchased for its fair market value at the date of the deceased person’s death? This is called a stepped up basis.
I recently prepared a tax return for a taxpayer and added over $50,000 to her AB as follows:
* She inherited 50% of the property recently and received a stepped-up basis.
* I examined the settlement sheet for the purchase of the property and added to AB transfer tax, abstract fees, taxes, surveys, recording, legal fees, and seller’s costs paid by the buyer.
* I check the settlement sheet for similar costs for the sale of the property.
* Likewise, the costs of selling a property that are not deducted are added to the property’s AB.
* Don’t forget to include the cost of the property’s lot which should not be depreciated.
* AB is increased by the cost of improvements to the property, like a new roof or appliances.
* There’s more.
If you have been a landlord for more than one year and have prior year unallowed passive losses on Form 8582 of your Form 1040, you will probably be entitled to offset those losses against your gain. If you are selling a business or investment property, you can seller finance and sell it in installments and delay the gain. Each year you will have gain equal to the percentage of the principal received in each payment. Finally, if you enter into a “like kind exchange” of the property, which may not be an exchange at all, you can delay the gain until the replacement property is sold. This reminds me that if you obtained the property being sold as a replacement property in such a like kind exchange your basis will be based on your AB in the previously replace property. This situation is far beyond the scope of this article.
