Tax Implications Of The Sale Of Rental Property: A Case Study On T. Terri's Apartment Sale

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Tax Implications of the Sale of Rental Property: A Case Study on T. Terri'sApartment SaleFACTS:Ms. T Terri purchased an apartment on February 21, 2010 for $3,000,000 with 90% of thepurchase price allocated to the building. 10% went to theland. She sold the apartment onSeptember 2, 2012 for $3,600,000 with 90% of the sales price allocated to the building. Thepurchaser paid T. Terri $600,000 cash and assumed a $3,000,000 mortgage on theproperty. T. Terri’s only other taxable property transaction during the past ten years wasthree years ago and it resulted in a Sec. 1231 loss of $100,000. (Normally, T. Terri engagesin wholly non-taxable Sec. 1031 exchanges.) While T. Terri owned the apartment, 100% ofthe gross rental income was “rental income from dwelling units” (You may assume that herrental of the apartment building was a profit-motivated “trade or business.”) T. Terri issingle and had a taxable income of $1,000,000 in 2012 (without including the taxconsequences of the sale of the apartment)IssuesPart 11.What is T. Terri’s realized gain or loss on this transaction? (Assume for purposes of Part1 only that T. Terri has, or will have, deducted in her federal income tax returns a total of$250,000 in depreciation on the apartment building through the date of the sale)Answer:To determine T. Terri's realized gain or loss on the sale of the apartment, we need to considerthe following:1.Selling Price of the Apartment:oThe apartment was sold for $3,600,000.

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o90% of the salesprice was allocated to the building, which equals:3,600,000×90%=3,240,0003,600,000\times 90\% = 3,240,000 (for the building).oThe remaining 10% was allocated to the land:3,600,000×10%=360,0003,600,000\times 10\% = 360,000 (for the land).2.Adjusted Basis of the Apartment:oThe original purchase price was $3,000,000. 90% of this amount was allocated tothe building, and 10% was allocated to the land.▪The building's initial basis was:3,000,000×90%=2,700,0003,000,000\times 90\% = 2,700,000.▪The land's initial basis was:3,000,000×10%=300,0003,000,000\times 10\% = 300,000.3.Depreciation Deduction:oT. Terri has taken a total of $250,000 in depreciation on the building, which willreduce the building's basis. The depreciation impacts only the building's basis, notthe land's basis.▪The adjusted basis of the building after depreciation is:2,700,000−250,000=2,450,0002,700,000-250,000 = 2,450,000.4.Mortgage Assumed by the Purchaser:oThe purchaser assumed a $3,000,000 mortgage, which does not affect the realizedgain directly, but we will need to consider it as part of the overall financialstructure of the transaction. For tax purposes, this is considered part of the saleproceeds.5.Amount Realized on the Sale:oThe amount realized on the sale includes the cash received from the buyer plusthe amount of the mortgage assumed by the buyer.600,000600,000 (cash received) + 3,000,0003,000,000 (mortgage assumed) =$3,600,000(total amount realized).6.Realized Gain or Loss Calculation:Realized gain (or loss) is calculated as the amount realized minus the adjusted basis ofthe property. In this case, we will focus on the building because the land is notdepreciated, and the land will likely have a different tax treatment.

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