Basis, Gain and the American Taxpayer Relief Act of 2012
Gain has absolutely nothing to do with profit. In fact, today we are handling exchanges for people that have lost property in foreclosure suffering what they perceived a total loss and yet they may have a gain!
Gain is simply calculated as follows:
Gain = the adjusted sales price minus the basis
Basis = The purchase price + improvements – depreciation
The “Purchase Price”
When calculating the basis one must consider the “purchase price” can be adjusted by the manor the property was acquired. If a property was acquired via a 1031 Exchange there was a basis carry forward from the relinquished property. If the property was inherited the property would have received a step up in basis to current market value. If the property was received as a gift the basis would be what it had been for the person granting the gift.
Investors must consider whether the “improvements” were capitalized or expensed. If the improvements were capitalized the basis would be increased. If the improvements were expensed the taxpayor would have received a write off and no increase in basis.
When it comes to depreciation the government has a “should have therefore you did” attitude. In other words, if an investment was to be depreciated it is possible you could have the tax hit triggered by depreciation recapture without having received the benefit of depreciation!
When a property’s debt exceeds it’s sales price there can be a “Phantom Gain”. The IRS considers the debt on a property to be it’s sales price when the debt exceeds the sales price. Therefore, if the debt exceeds the basis there will be gain upon a transfer!
There is relief from Phantom Gain on a primary residence under certain conditions, make sure you understand the guidelines for qualification! Investment property does not have any exclusions.
Calculating the Tax
When calculating the actual tax hit you must consider Federal, State, whether AMT may apply and now IRC §1411 adds a 3.8% Medicare surtax on net investment income which includes capital gains.
The result is an overall Federal tax rate for higher-income taxpayers of 23.8% on gain attributable to appreciation and 28.8 on depreciation recapture.
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January 1031 & IRA Oregon Continuing Education Courses
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IRC 1031 & Section 121
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*1031 has been spared with tax reform and actually simplified in some instances
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Wednesday January 31st, 2018
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