Contact your CPA firm before you act!
We have a client who is a non-resident alien. Because he rents his two Florida condos, he is required to file tax return 1040-NR each year to report the rental income and expenses. In October of 2017 the client brought in their 2016 tax information, and that is when we discovered that they sold one of their condos - at a loss. Per the FIRPTA rules (Foreign Investment in Real Property Tax Act of 1980), 15% of the selling price was sent to the IRS as FIRPTA withholding. If the client had contacted us as part of their planning for the sale, we could have helped them avoid the withholding requirement. Then they could have kept their $62,000 in 2016, instead of having to wait another 6 months after filing to receive their refund in 2018.
Another client sold a vacant lot that they were holding for investment. We found out about the sale in April when they brought in their tax return information. The sale took place in August of the previous year and they subsequently used the proceeds to purchase another vacant lot as an investment in December; about 4 months after the sale of the first lot. They paid more than $32,000 of capital gains tax on the sale. Had the client contacted us as part of their planning, they may have been interested in knowing that they could have saved the capital gains tax as part of a section 1031 Like-Kind Exchange.
My last example of the cost of not planning involves a client who sold their rental condo. By law, rental property must be depreciated, and as you depreciate the asset, the base price goes down by the amount of the depreciation expense taken. That drives up the capital gain when sold; called depreciation recapture, and that layer of the total capital gain is taxed at 25% per IRC 1250. It works like this; if you buy a condo for $100,000, rent it for 5 years, and then sell it for $120,000 you might think that your gain was $20,000. The problem is that over 5 years you took $18,180 of depreciation expenses, and now your cost basis is decreased to $81,820 ($100,000 – $18,180 = $81,820 adjusted basis), and that means that your capital gain is not $20,000 but $38,180. The $20,000 portion of gain was taxed at the regular rate of 15%, but the 18,180 is taxed at 25%.
The family that sold the condo expected some capital gains tax, but they did not expect owing the IRS over $24,000 instead of receiving their usual refund. To make things worse, they sold their rental condo and used the proceeds to buy a second, better, rental condo. Had they contacted me when they were planning, not only would they have known about section 1250 depreciation recapture, but they probably could have avoided the gain altogether by using a section 1031 Like-Kind Exchange.
Call us before you make those big transactions. It might be the best $200 you spend that year.