Q: I own an investment home that has been depreciated down to $25,000. I expect to sell the property later this year for $70,000, with the buyer assuming the existing mortgage of $35,000 and giving me a second trust for the other $35,000. My question has to do with the amount of immediate capital-gain tax I would owe. As I read the rules, I would have to report $10,000 this year -- the difference between the $35,000 mortgage the buyer is assuming and the $25,000 adjusted cost basis. But a friend says the 1984 tax law changed this; that I would owe tax on an immediate capital gain of the entire $45,000 ($70,000 minus $25,000) even though I collect no payment at all this year. Who's right?
A: You're both partly right. The 1984 law did make a change in the handling of Code Section 1250 property (essentially, depreciable real property held for investment or income). The situation is so complex that I couldn't possibly explain it in this space; and I would need considerably more information than you have provided to tell you just what you must do. But perhaps I can briefly explain some of the details.
For sales made after June 6, 1984, depreciation recaptured under Section 1250 must be included as income in the year of the sale, even though reporting of the gain normally would be deferred under the installment method. The amount of recapture depends on the period of ownership and the type of depreciation taken on the property.
But the reporting of gain in excess of the amount of recaptured depreciation may be deferred under the installment method until payments are received in later years. So if the depreciation recapture doesn't exceed $10,000, you need only report the $10,000 gain in the year of sale.
If the recapture total exceeds that $10,000 figure, all of the recaptured depreciation must be reported as ordinary income in the year of sale. But then the total gain to be reported as the installments are received should be reduced by the amount of recapture that had already been reported as ordinary income.
Because as a general rule -- but not an absolute, all-inclusive rule -- recapture is only required for depreciation in excess of straight-line, you're not likely to have a great deal of recapture to report as ordinary income. So you will be able to defer the tax on much of your capital gain until the installment payments are received.
If you weren't confused when I started, you probably are by now. The free IRS Publication 537 on installment sales may be helpful; but I really think you could use professional help in this matter. Yours is not an unusual situation; I've included this complicated discussion here as a warning to all readers not to make "obvious" assumptions in tax matters. Unless and until we get true tax simplification, it's a pretty good bet that solutions are more complex than they appear on the surface.
Q: My wife gained custody of her son by a previous marriage in March 1984. Since that time her former husband has become delinquent in child support payments of more than $2,000. Since the first of the year my wife has spent approximately $1,500 in attorney fees and court costs attempting to recover these delinquent payments. Is there a tax deduction for these delinquent payments? Is there a tax deduction for these expenses? Does it depend on how much, if any, of the delinquency she collects?
A: None of your wife's legal fees or court costs are deductible on your tax return -- because the child support payments are not taxable income when received. Nonbusiness legal fees provide an income tax deduction only when associated with income-producing property or with income that is taxable upon receipt. For example, legal expenses to collect delinquent alimony payments would be deductible, because alimony is taxable income.
The answer is the same whether your wife is successful in collecting all, part or none of the delinquent payments. If her former husband is solvent, however, it is possible that she can convince the court to order him to pay all or part of her collection expenses in addition to the back payments. Her attorney can advise her if such costs are recoverable in her particular jurisdiction.