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Edsel

Section 1250 Problems

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To put this into perspective, this client will have an AGI well over $1MM.

A large part of this will be the sale of commercial real estate.  We elected component depreciation - such things as heat pumps, furniture, etc. were given shorter lives than the 39 years, and much of this is fully depreciated.

The questions are as follows:

  1. Are the components eligible for the 25% ceiling on 1250 property?  I don't think they are but I thought I would ask.  I believe them to be mostly 1245 property.  They were purchased as 1245 property and depreciated as such.
  2. How do you allocate the selling price between 1250 and 1245 property?  The initial building was purchased in 1984 for $475,000 but should be worth over $1,000,000 in today's money.  The 1245 property was purchased along the way, timewise.

Thank you in advance to those who respond...

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55 views so far but no responses?  Either no one knows, no one wants to take time to respond, or everyone believes I should already know the answer...

Thank you in advance to those who respond...

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You can't have the best of both worlds. Since you depreciated as 1245 you recapture as 1245.

You allocated based on fmv.

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Thank you DANRVAN.  It's hard to allocate based on FMV when the taxpayer does not provide a separate appraisal.  That means the tax preparer has to take a shot at it or ask the taxpayer to pay an appraiser extra.  Appraisals are usually required somewhere on the sale of real estate, but they never give a separate appraisal for equipment/fixtures.

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Because you need relative values, percentages to allocate, can you use the depreciation values, the original cost basis, to compute the percentages? I'd rather have sales values, but I'd rather the client do the research or pay an appraiser! How much will your client pay you? Is it enough to research current FMVs? Do you even have the time without shorting your other clients?

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I see problems with allocating all assets based on original cost.

First of all, while the value of the real estate has more than doubled, the value of the other assets have most likely decreased.  Because of that, your client will end up with overstated 1245 gains and understated 1250 gains; to his disadvantage.

The question is how much is it worth to find the fmv of the personal assets?  If an appraisal is not feasible then work with the client to come up with values.  I am cautious as an accountant to never put on an appraiser's hat but will use my judgment on what is reasonable.

 

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When I first got into taxes back in 2005 I was on a board like this. Any time a question like this would come up, the same poster would declare something to the impact of "If the client refused to get a full appraisal on every item and didn't deliver it to me in a timely manner, I would immediately fire them." There was usually a part added on about legal liability he had surmised if his demands weren't met. Always wondered if he was trolling or had 2 clients left.

 

Same guy always declared every small business tax return he did had to have a full audit of their accounting by him or he wouldn't sign the return. Somewhere he'd determined that by signing the return we were guaranteeing to the IRS the validity of everything the client provided us.

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This may not fit your situation depending on what the 1245 assets are, but I've often used their sale price as their remaining basis.  If you bought a water heater for $1k 10 years ago, its basis is zero--which is exactly what a willing buyer would be willing to pay for a 10-year-old water heater.  Same with awnings, driveways, used furniture.  Usually the amounts involved aren't that big so it doesn't over- or understate the total profit a heck of a lot.  There is a form where the buyer and seller agree on the purchase price of each asset (8594?), but I have never seen one outside of tax classes.  You can tell your client to take a stab at it and see if the buyer agrees to those numbers as those will be his/her basis going forward.  (Warning:  the seller will want low valuations to minimize profit whereas the buyer will want high valuations so there is something left to depreciate.)

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I am inclined to agree with DANRVAN about the value of real estate versus depreciable equipment.  Under theory, the equipment is worth less as time goes by, whereas real estate increases.

What I ended up doing:  Allocate the original value spent on the s. 1245 when new, subtract this from the total sale, and the remaining price is thus allocable to the s. 1250 assets.  The result:  s.1245 gains were depreciation recapture and ordinary income, and there was significant capital gains on the real estate as well as s. 1250 recapture capped at 25%.

Something else to think about, and it's not very professional.  I often wonder what an auditor would do and whether he/she would go to a lot of trouble creating an adjustment.  In this case, the lack of an appraisal might cause heartburn with the auditor, but then he/she would have to write up an adjustment.  In other words, in order to do his/her job, the auditor would have to use appraisal techniques and suffer from the same lack of appraisal as the preparer.  My experience is if an auditor is confronted with a difficult and time-consuming detail with questionable results, they are inclined to back away.

 

 

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13 hours ago, SaraEA said:

This may not fit your situation depending on what the 1245 assets are, but I've often used their sale price as their remaining basis.  If you bought a water heater for $1k 10 years ago, its basis is zero--which is exactly what a willing buyer would be willing to pay for a 10-year-old water heater.

We may be wrong but that's how I'd do it also. Any value in that 10 year old water heater is less than the cost of an appraisal.

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On 5/29/2019 at 7:16 PM, Edsel said:

Something else to think about, and it's not very professional.  I often wonder what an auditor would do

I don't see anything inappropriate with that.  When working in a gray area where the IRS might take a different view I think it is a good idea to estimate what an adverse ruling might  cost the client.  

If I am reading your last post correctly, it looks like you are taking a conservative approach by valuing the 1245 stuff at cost, so the maximum recap will be depr. allowed /allowable.

In regards to the H2O heater example above,  even though the asset might not have any salvage value,  it does have value to the buyer of the building.  While that value might not be  much by itself, accumulated with other items the value can be significant.  For example, say there are two equal buildings for sale except one needs a whole bunch of fixtures etc replaced. 

The building that has all the fixtures working is going to have more value even if they are fully depreciated, vs the building that needs thousands of dollars of new stuff to make it usable. That extra value comes from those depreciated assets.  I would not let the finger point at me when the question arises as to how the assets were given a zero value.

Now getting back to your question as to what the auditor is going to say.  That would depend on fact and circumstances and potential understatement of income.  The IRS will bring in their own experts when feasible as we see in tax court cases.

 

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