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QUESTION: I took out a home improvement loan to build a garage apartment behind my home that I now rent out. After deducting for expenses (mortgage, property taxes, utilities) I just about break even. I would rather not claim depreciation or file a Schedule E. If I report this as a (truly) not-for-profit rental, deducting expenses where allowable on Schedule A, will the basis of the garage apartment be reduced for recapture of depreciation when I sell my home though I didn't claim it?

I have been trying to research this question for days -- even asked a CPA friend of mine -- but you're the only expert I've found who has come close to actually answering it, back in 2009.  But it wasn't clear to me whether skipping Schedule E and reporting the income on line 21 would make a difference regarding recapture down the road.

Thank you for any help you can give me.

ANSWER: Brenda,

Thanks for your question.

Let's talk depreciation first.  The rule is that the IRS will reduce your basis in a depreciable asset for depreciation "allowed or allowable." In other words, they reduce your basis whether you take the depreciation or not.

If you have a rental not for profit, you are not allowed any depreciation unless you have taken mortgage interest, property taxes, and other expenses of the rental.  If you have taken all those and still have a profit, you are allowed to deduct depreciation to the point you have a zero profit. This depreciation will reduce basis and involve recapture down the road.  

Keep in mind, that with a rental not for profit, you cannot show a loss.  You can only deduct expenses up to the point where you have no profit.

Hope this helps.

John Stancil, CPA



---------- FOLLOW-UP ----------

QUESTION: John, thank you for your clear and concise answer to a surprisingly difficult question.

Does this mean that in the case of a not for profit rental property, the IRS would recapture no more depreciation than what had actually been deducted in prior years? In other words, only the amount that was needed to result in zero profit, not the amount allowable (1/27th of the basis) under ordinary circumstances?

If this is not the case -- if the recapture would not be reduced -- I don't see the point of claiming a not-for-profit rental. There would be no tax benefit either on the front end or back end.

ANSWER: The IRS would recapture any depreciation allowed, whether taken or not.

Your final statement concerns me.  It is either a rental for profit or not for profit. Your intent is the issue here, not any tax advantages or whether or not a profit is being generated.

John

---------- FOLLOW-UP ----------

QUESTION: Sorry to sound wishy washy. My intent is to break even on the rental apartment, not to make a profit. Nor do I want to claim a loss if expenses exceed income.

My confusion has to do with the definition of "any depreciation allowed." Ordinarily that would be 1/27th of the basis each year. But under a not-for-profit scenario, deductable expenses (including depreciation, if taken) would be capped at the point they equal income. It seems like that would result in a lower "allowable" depreciation for that property -- and less to recapture down the road.

However, it sounds like the IRS doesn't split those hairs. Apparently "allowable" depreciation is always defined under the usual scenario (1/27th of the basis), instead of a not-for-profit scenario which reduces the depreciation an owner is permitted to take.

Thanks again for your help. As you can see, I need it.

Answer
While the IRS does not (to my knowledge) address this directly, there are several references to "allowed deductions." Normally, in a rental not-for-profit, there is little or no allowed depreciation due to the rules that state you can't show a loss in these cases.  Therefore, the depreciation is not allowed and is not included in the recapture provisions. Additionally, the purpose of the recapture is to have you pay tax at the same rate that you took when you deducted it.  Since you never deducted it, there is no need for recapture.

John

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John Stancil, CPA

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I can answer questions on personal income taxes, partnerships, and some corporate income taxes. I can deal with some state tax questions. Limited gift and estate tax questions. I am also familiar with ministerial and church tax reporting issues. I am Professor Emeritus at Florida Southern College. Sales taxes and property taxes are state and local issues so I am not likely be be able to give you an in depth answer on those types of taxes. I have maintained a CPA practice, specializing in tax, for over 35 years. I am a member of the National Association of Tax Professionals, The Florida Insititute of CPA's, The NCPE Fellowship. In addition I am a Certified Mentor for SCORE. Visit my website at www.mybaldcpa.com. I also offer seminars and consultations to churches and clergy on their tax issues at www.churchtaxsolutions.com Also visit my blog, www.thetaxdocspot.com. I am listed on Tax Connections at https://www.taxconnections.com/profile/John-Stancil/12258973 Prepare and file your own taxes at www.1040stancilcpa.com

Experience

I hold a doctorate in Accounting, and am a CPA. My certifications of CIA, CFM, and CMA are inactive. I passed all certification examinations on the first attempt, and received honorable mention for my scores on the CIA exam. I have operated a CPA firm for over 37 years and have taught accounting and tax at the college level for over 35 years.

Organizations
FICPA, NATP, NCPE Fellowship, Lakeland Business Leaders

Publications
The CPA Journal, Florida CPA Today, Green Consumer, Green Business, Global Sustainability as a Business Imperative, Palmetto Review, NATP TaxPro Quarterly, Mustang Journal of Finance and Accounting.

Education/Credentials
DBA University of Memphis MBA University of Georgia BS in Accounting Mars Hill University

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