Course:  Income Tax Planning
Lesson 15: Property Transactions

Student Question:

Running with the last example on this page where the sale is between the 
basis for a gain or a loss, is there ever a situation where factoring in depreciation would result in either a gain or loss?

Example

Kevin’s home has been declining in value, so he has decided to move and rent it. When he converts the home to rental property, the fair market value is $200,000, while his adjusted basis is $250,000.

Basis for determining a loss / depreciation

Kevin’s basis for determining a loss is the lesser of the FMV, $200,000, and the adjusted basis, $250,000. Therefore, Kevin’s basis for determining a loss is $200,000.

Basis for determining a gain

Kevin’s basis for determining a gain is the adjusted basis, $250,000.

So, if Kevin sells the home three years after converting it into a rental property, and depreciates it $8,000 in that time, what would he report if he sold the home at the following amounts?

  • $290,000: If Kevin sells the home for $290,000, he would use the adjusted basis of $250,000, less the $8,000 depreciation, as his basis. Therefore, Kevin would report a gain of $48,000 ($290,000 – $242,000).
  • $100,000: If Kevin sells the home for $100,000, he would use the fair market value of $200,000, less the $8,000 depreciation, as his basis. Therefore, Kevin would report a loss of $92,000 ($100,000 – $192,000).
  • $215,000: If Kevin sells the home for $215,000, he would not report a gain or loss. This is because by using the basis for a gain, Kevin would have a loss of $27,000 ($215,000 – $242,000) and using the basis for a loss, Kevin would have a gain of $23,000 ($215,000 – $192,000).

Jay


Instructor Response:

Good question, Jay.
 
We know Gain = Sales Price > Adjusted basis.
 
and

Loss = Sales Price < a cost factor. 

  • The cost factor is the lesser of fmv on conversion date or adjusted basis.  

Because depreciation reduces basis to arrive at adjusted basis, depreciation is absolutely a factor.  
 

Dan