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Case Study - Partially Residential Property

Tom Stonehouse, a 72-year-old taxpayer, owns a four-unit apartment building that he had purchased five years ago. He occupies one unit as his personal residence and rents out three units. Desiring to move to a warmer climate, Tom decides to sell the building and move in with his nephew. Tom's records show the following:

Cost of building $80,000
Capital improvements + 8,000
  $88,000
Less: Depreciation on rental units -10,100
Adjusted basis $77,900

Tom sells the building on May 1, 2014, for $220,000 and incurs selling expenses of $10,000. Since only one-fourth of the building was used as his personal residence, Tom would compute his gain as follows:

  Apartment Residence Rental Building
Usage allocation (1/4) (3/4)
(1) Selling price $ 55,000 $165,000
(2) Selling expenses - 2,500 - 7,500
(3) Amount realized (adjusted sales price) $ 52,500 $157,500
(4) Basis (including improvements) $ 22,000 $ 66,000
(5) Depreciation   - 10,100
(6) Adjusted basis $ 22,000 $ 55,900
(7) Realized gain ((3) minus (6)) $ 30,500 $101,600
(8) Gain subject to exclusion $30,500  
(9) Gain subject to tax   $101,600

Of the gains subject to tax on line (9), $10,100 is taxed at a 25 percent rate because it represents depreciation that must be recaptured. The remainder would be taxed using the capital gains tax rates.since he held the property for more than one year.

Also, the gain on the sale may be included in net investment income for purposes of computing the net investment income tax. A 3.8 percent net investment income tax applies to individuals whose modified adjusted gross income exceeds $250,000 for joint filers, $125,000 for married taxpayers filing separately, and $200,000 for others.


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