Wednesday, December 27, 2006

Depreciation In Year of Sale

Karen from Ohio asks:
I have a question about how much depreciation I should use on a rental property that I sold. I placed the property in service on Nov. 1, 2000, using MACRS (GDS), straight line depreciation, mid-month convention. If this were a normal year, as the past few have been, I could depreciate 3.636% of the basis. The date of the sale was 4-23-06.

So, I figure that I can use 1.212%, since I owned the property for 1/3 of the year and 1.212% is 1/3 of 3.636%. But I just did this math on my own, and I couldn't find any official IRS info about this--but this kind of occurrence should happen all the time, as very few people will depreciate their RE over the full 27.5 years.

I must be close to the right answer on this, but what should I really do? Do I have to count days. (Including April 23th in the count?)


My response:
Depreciation is a complex area of tax and accounting. I do not recommend that anyone try to compute their own depreciation. I will assume that you are referring to "regular" Federal depreciation schedules, but taxpayers should be aware that property may be depreciated differently for State, AMT (another Federal method) and ACE (yet a 3rd Federal method). So, even if I help you figure out your regular Federal depreciation amount, you still have depreciation work to do, which is usually best left for your tax professional.

Now to answer your would also use mid-month for the year of disposal. In YOUR case the "factor" or percentage that you would multiply your basis by would be 1.061%. This is 3.5 twelfths of the full year factor that you were using (3.636%). And why 3.5 twelfths? Because of the mid-month convention. Your property was sold (as far as the IRS is concerned) on April 15, which is 3.5 months into the year.

It should also be noted that when computing the gain or loss on disposal of property the depreciation allowed is used whether the depreciation expense was taken or not. Deciding not to mess with depreciation or taking a lessor amount than you are allowed will save you nothing.

And one final note...with proper advanced tax planning, taxpayers can use a 1031 exchange to postpone the gain.

Best wishes,

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