Depreciation Recapture (and Condo Converting)

[John Boy]

Hi Guys,

So I am trying to (finally) figure out the truly correct way to calculate my taxes on an underperforming 2-family property I'm going to sell soon (for purposes of below, I plan to sell in June 2015 and have estimated applicable numbers thru then). So here are a few ballpark numbers:

1) Initial Cost Basis (Purchase + Closing Costs): ~$677k (2008)

2) Total Depreciation Taken (2008 thru June): ~$166k

3) 25% Tax on Depreciation: $41,450

4) Cost Basis + Depreciation: ~$843k (#1 + #2)

5) Estimated Net Sales Price (as-is): between $650 and $725k

6) Estimated Net Sales Price (Condo Conversion): between $725k and $825k

7) Existing Mortgage (as of June): ~$424k

8) Potential Proceeds (as-is): between $226k and $301k (#5 minus #7)

9) Potential Proceeds (Condo Conversion): between $301k and $401k (#6 minus #7)

Now, for my TAX question:

1) Am I figuring out my taxes the right way by saying:

a. My tax liability for depreciation recapture will be $41,450 (the 25% tax on Depreciation Taken); and then

b. I will show a paper/passive loss on the property because Cost Basis + Depreciation equals $843k, but will not have net proceeds for that amount (so my net loss will depend on the sales price)?

c. Or is the way I have figured it in #b above (Cost Basis + Depreciation or #3 above) NOT the right way to figure out the Total Cost Basis...is it just the actual Cost Basis (#1 above) minus the Net Proceeds?

And now for my CONDO CONVERSION question:

1) I was just informed by my lawyer that if I do a condo conversion, then any gain from the sale is automatically taxed as ordinary income, regardless of how long I held it (because the IRS views the intent as a "flip"). So in this situation, assuming the way I figured out my taxes in 1a & 1b above are correct, it won't really matter since I am showing a loss either way, correct? Or if #1c above is the correct way to figure out the gain, then might I be liable for ordinary income on this property if I do a condo conversion, vs. long term capital gain if I sell it as-is as a rental property?

sorry for the long question. thanks all