Tax Worksheet (Sch D(1040)

[Christian]

A client sold a much depreciated rental last year. I expected to use the Qualified Dividends and Capital Gains worksheet for the tax. Instead because there was a gain on line 19 and lines 15 and 16 of Schedule D I had to use the above named worksheet which produced a hugely higher tax. I worked through it and to say I am totally mystified is a gross understatement. Can anyone briefly explain what the objective of this worksheet is and is my reading correct for this particular situation that is to say a large capital gain produced by the sale of a largely depreciated rental house? Is this the worksheet used to compute the tax due instead of the more familiar Qualified Dividends and Capital Gains worksheet ? Of course ATX did this automatically but I went back and checked the calculations on the worksheet. The sale is reported on the Form 4797 and the depreciation expense was entirely straight line for a 27.5 year period.

[Christian]

Oh great depreciation recapture what a great concept. Boy the client is going to love this ! I've not dealt with this in more years than I can recall and , of course, he did not call me to advise he was selling the property last year. I will likely be fired for no fault of my own. 

 

[jklcpa]

This whole topic from April 2022 has a discussion that may help you make sense of the 1250 gain and how to best explain it to your client.  Edited - don't know why it started with my post from that earlier topic, maybe where I left my screen.  Interestingly, this one was also started by Christian.

 

[Christian]

I worked through the worksheet and finally see what was done. It taxes the accumulated depreciation as ordinary income and taxes any capital gain above the depreciation at 15% along with his qualifying dividends by a convoluted roundabout method Rube Goldberg must have thought up. The client has now set up an inherited house for a rental and has incurred a loss on it which cannot be deducted. Is there an IRS form showing accumulated passive losses so he will not need to retain his own ? Or does the Form 8582 carry them forward as needed ?

[joanmcq]

8582 will carry them forward

[Sara EA]

If the client used MACRS, there isn't depreciation recapture on the real estate portion.  Instead, basis is reduced by the depreciation allowed or allowable, increasing the cap gain.  Gain is calculated on 4797, not the Sch D worksheet, and transferred to Sch D.  If they used ACRS, different story.

[Christian]

The client's property was set up in 2011 and had a porch added a few years later. Both were set up using SL/GDS and were entered on the Form 4797. ATX used the Schedule D worksheet noted above noting the accumulated depreciation on line 19 of Schedule D. Essentially it adds back all the depreciation to his income for 2022 taxing it at his regular tax rate. Let me know if this is incorrect and if so what I can do to change it. I am holding the return to go over it more carefully there is a lot of tax involved. I cannot recall how long it's been since I last had one of these and am using extra caution to insure his return is correct.

Both the house and porch were set up for 27.5 years.

 

[DANRVAN]

37 minutes ago, Christian said:

depreciation to his income for 2022 taxing it at his regular tax rate

 

That is correct.  The unrecaptured section 1250 is a capital gain which can be offset by capital losses,  but taxed at a maximum ordinary rate of 25%.

[Christian]

He set up a house he inherited from his mother last year and posted a loss from that but his income prohibits taking this passive loss against regular income sources he has W-2, interest, dividends, tax exempt interest and a pension inherited from his father. Could this loss be applied to the capital gain or rather part of it realized on the sale of his older rental and if so how is that reported ? 

[Lee B]

According to CCH Answer Connect:

"The passive activity loss rules generally limit the ability of taxpayers to shelter salaries, wages and interest income with deductions and credits from passive activities, that is, trade or business activities in which the taxpayer does not materially participate. Under the passive loss provisions, taxpayers can generally only deduct a loss from a passive activity to the extent of income generated by the taxpayer's other passive activities. The passive activity loss cannot be deducted against salary, self-employment earnings or investment income from dividends or interest. Any disallowed passive activity losses are carried forward indefinitely (suspended) and deducted from passive activity income in future years until the taxpayer either has offsetting passive income or disposes of his or her interest in the passive activity (or substantially all of the activity) in a taxable transaction. Similarly, credits from passive activities that exceed the tax liability allocable to passive activities for the tax year must be suspended and utilized to offset tax liability from passive activities in future tax years."

[jklcpa]

4 hours ago, Christian said:

He set up a house he inherited from his mother last year and posted a loss from that but his income prohibits taking this passive loss against regular income sources he has W-2, interest, dividends, tax exempt interest and a pension inherited from his father. Could this loss be applied to the capital gain or rather part of it realized on the sale of his older rental and if so how is that reported ? 

The passive activity loss in the current year or the suspended passive losses from prior years CAN offset the gain on sale if it comes from a passive activity.  It must be a complete disposition that creates that gain, and it should all be handled through form 8582.  Sorry I can't help with your input as you know I do not use ATX any more.   

[Sara EA]

Do you mistakenly have the property marked as Sect 1245?  UT defaults to that. and you have to change it to Sect 1231.

[DANRVAN]

6 hours ago, Christian said:

He set up a house he inherited from his mother last year and posted a loss from that

 

So you have two rental properties on Schedule E, one that was sold (A) and the other with a disallowed loss (B).

 

On 4747 input did you specify the sale related to property A?

 

On the Schedule E input sheet for A did you check the box that it was a complete disposition of a passive activity?

 

Those steps should net the loss on B against the gain of A. 

[Christian]

jklcpa has essentially answered my question. The sale of his old rental was the complete disposition of a passive activity and the loss produced by setting his inherited house in 2022 is also passive. So I will look at form 8582 to see if this helps my client. No the property was a house rental clearly 1250 property. I checked Form 8582 and see no way I can deduct the current 2022 passive loss from his new rental from the capital gain produced by the sale of his older rental in 2022.

[DANRVAN]

3 minutes ago, Christian said:

and see no way I can deduct the current 2022 passive loss from his new rental from the capital gain produced by the sale of his older rental in 2022.

 

Did you check the boxes mentioned in the above post?  It should then flow to 8582.

 

7 minutes ago, DANRVAN said:

On 4747 input did you specify the sale related to property A?

 

On the Schedule E input sheet for A did you check the box that it was a complete disposition of a passive activity?

 

[Christian]

I wish to express my sincere appreciation to all of you who took the time to respond to this post and particularly to Danrvan who provided what turned out to be the final piece of this puzzle. I have just finished working on this at 12:15 AM and the client will save over $2,000 in taxes as a result of my persistence but I would never have achieved this result for him without yauall's kind help to me. This is why I appreciate this forum so much as youall's far greater experience in tax matters is always so generously shared with us of lesser wisdom.