Sale of Rental Property Affected By Depreciation and Loss Deductions

Q: I inherited a rental property in 1991 when my dad died. I am thinking about selling it. The taxes were assessed in 1992 at $30,000. I have had losses on the property for several years with no income and repairs that I had to do. How do I determine how the sale of the property will affect my income taxes?

A: We’re not accountants and you’d probably want to talk to one about your situation for a variety of reasons.

Let’s start with depreciation. When you own a rental property, you might depreciate it, which should lower the income tax you pay to the federal government. When you sell the rental property, you have to repay some of that financial benefit back to the federal government.

If you’ve had losses from the property over the years, you might have been able to take tax deductions for those losses and reduced the amount you paid in your federal income taxes.

You’ve owned the property twenty years. During that time, the tax rules governing rental properties have changed, and your return will be affected. For some of those years, you might have benefitted from tax losses from the property while in more recent years those benefits have been reduced significantly due to changes in the tax laws.

If you had years in which you had losses, you might be able to carry forward some or all of those losses to reduce your possible federal income taxes now.

Another issue for you to contemplate is determining the value of the property at the time you inherited it. While you say that it was assessed for tax purposes at $30,000, you’d need to know whether it was actually worth that much (or more) at that time you inherited it. In some parts of the country, the tax valuation has no reasonable relationship to the property’s actual value.

But if the property was worth that amount, that’s just the start of the property’s cost basis. You have to add in other improvements made to the property that were not depreciated.

Let’s say you spent an additional $200,000 over the years on long-term improvements, including a new roof, an addition onto the property, and new windows. And, let’s say it costs you $30,000 in expenses to sell the property. These costs would be added onto the cost basis of the property and could reduce the amount of tax you owe, perhaps all the way down to zero.

Start by determining the value the value of the property at the time you inherited it. Then add up all of the long term improvements you have made to the property over the years. Add up all the yearly losses you have had on the property. Add up the depreciation you have taken on the property.

Once you have that information and documentation to back it up, you can sit down with an accountant and try to get a rough estimate of what you might owe if you were to sell the property now.


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