Capital Gains after property split?

[Elvis T Santana]

Hello BP Community!

I purchased a property for $220k 6 years ago in Fall River, MA. Two houses on one lot/deed/title - a 3-family and a single family. It was mortgaged as commercial since I was not a MA resident at the time. I live in the 3-family now and still have the commercial loan.

The city approved a property split. I now have two deeds and can sell off the single family. Lender will facilitate partial release. I assume/expect the single family to be listed for 220-240k

Do I have a capital gains issue?

One person said no because of overall cost basis. Someone else said the cost basis may be 25% of the purchase price because I am selling one of four rental units.

All feedback is greatly appreciated!

[Michael Plaks]

@Elvis T Santana

Yes, you do have a capital gain issue. The question is how big of an issue.

For tax purposes, you own 2 properties: the 3-unit and the 1-unit. (You actually need to split the 3-unit between personal and business, too, but it's a different story.)

You need to allocate your cost basis of $220k between these two properties. In fact, you should have done it 6 years ago when you started renting the house for the first time, to set it up for depreciation. I'm concerned that it was not done and you possibly did not take depreciation - a major problem that needs to be fixed by a tax professional, if my hunch is correct.

Let's say the allocation was $150k to the 3-unit and $70k to the house. Then you have a capital gain on the difference between the expected sale price of $230k and the $70k basis. Adjusted for closing costs and major improvements, but still pretty significant.

In addition, you should have taken depreciation on the $70k property for 6 years and now need to return ("recapture") the tax benefits of this depreciation. If you did not take depreciation, you need to fix it, because you STILL must recapture depreciation, even if not taken.

In short - I believe you need professional help, including with the proper treatment of the remaining 3-unit.