Cost Basis is driving me crazy! Help!

I have a rental property I bought in 2005,

At closing I had to come up with $5800. I have depreciated the property every year since 2005. The sale price of the home was $123,000.

House burns down in 2007. I short sale property to mortgage company, 1099-C is what I receive for $2562.63 of debt cleared.

Claim property on insurance. Sell what’s left of property for $2,000.

Is my cost basis $123,000 minus 2,000 (sale) and minus what I paid in depreciation?

Or, is my cost basis $5800, minus the sale minus the depreciation?

You purchased the property for $123K in 2005. You sold the property in 2007 for $2K.

Your closing costs in 2005 were $5800. How much of your closing costs did you expense on your Schedule E?

How much depreciation did you take on the property up to the time you sold it?

Did you make any capital improvements to the property while you owned it?

What was your mortgage balance at the time of your “short sale”?

Did you receive any money from the insurance company following the fire or did the mortgage lender get it all?

Answer these questions and maybe we can help compute your cost basis as well as suggest the amount of your gain or loss.

Thanks for the reply!

Here are the answers to your questions:

I did not expense any closing expenses on my 1040 Schedule E
I made $16,587 worth of capital improvements all backed with contracts/receipts
Total depreciation was $3650
Mortgage balace was $126,500 due to early payout penalties
Mortage lender got all the money, I received none.

I appreciate you taking the time to respond.

Let’s start with your cost basis.

You bought the property for $123K and had $5800 in closing costs for an initial basis of $128,800. Add $16,587 to your basis for capital improvements which brings your basis to $144,787. Lastly subtract the $3650 in depreciation which gives you an adjusted basis of $141,137.

Your depreciation expense seems low for two years of ownership. Did you give us the total of all depreciation taken or just what you took in the past year? If you took more depreciation that $3650, then adjust the cost basis accordingly.

Now, let’s figure out your sale profit or loss.

You sold the property for the insurance settlement plus $2000, but then also got a deficiency judgement for $2563, so your net on the sale is $125,937 ($126,500 + $2000 - $2563).

It would appear that you have a capital loss on this property of $15,200. If you paid any settlement costs on the $2000 sale, then that amount would also be subtracted from your net on the sale, making your loss even greater.

Just how I see it. If I have it wrong, one of the CPAs on this board will correct the numbers.

I would challenge the mortgage lender on any prepayment penalty you had to pay. You did not sell the property or refinance it to pay off the loan, you had a casualty loss. I would hope that a prepayment penalty would not apply or that the mortgage lender would waive the prepayment penalty in your situation. If they rebate the prepayment penalty, then your deficiency judgement can go away, right?

If you don’t mind sharing more of your experience, why didn’t you use the insurance settlement to rebuild? The settlement should have been large enough to pay for reconstruction.

Thanks a million for the explanation!

Basically, I would have loved to rebuild but I did what alot of young motivated real estate newbies do…I tried a manage a property I had no business managing. It was in a horrible area, the property was a mess and the tenants were some of the most ruthless disgusting people I have ever met. At first I had a tenant that would call me threatening to kill me and rape my wife, after an eviction and continuous calls to detectives and police I hear he ended up getting arrested for double homicide here locally in the city during a drug deal.

I wasn’t experienced enough to keep it going, it was a money pit and the area just turned to crap. It was a college area but after moving most of the student areas during a remodel alot of the students moved out of those duplexes and they seemed to be filled with druggies.

Long story short, the property burned down because my evicted tenants broke in to shoot dope in my attic. I was fined so many times by the city, it just wasn’t worth rebuilding and add the pressure of the historic district my costs would have been huge. Lesson learned, I have only myself to blame.

During the time of waiting for insurance payout my insurance agent I believe was literally too scared to inspect the property, months went by and I got behind on my payments only have the home go into pre-forclosure. Months went by and after the rain destroyed the property due to having an open roof my agent just gave up and paid out the policy to the lender.

It was basically short sold back to the lender after prepay penalties, they were very difficult to work with and I was thankful to just be done with it.