Depreciation Brings Tax Despite Sale Loss

QUESTION: About five years ago I foolishly bought a small apartment building. It has been nothing but one headache after another involving both tenant and repair problems. Last month I sold the building for just slightly less than my cost. But my accountant says I will owe tax on my sale. How can that be if I sold for less than my purchase price?

ANSWER: For each of the five years you owned the building you probably deducted depreciation expense on your income tax returns. Depreciation is a non-cash bookkeeping estimate of wear, tear and obsolescence. As a result, your book value for the apartment building declined each year.

Suppose you paid $100,000 for the building and depreciated $1,000 per year for the last five years. Therefore, your depreciated book value is $95,000. If you sold the building for $100,000, you then had a $5,000 taxable capital gain.

Tax Return a Way to Figure Costs

Q: We are considering buying an apartment building adjoining one we already own. Owning twice the number of apartments will greatly increase our management efficiency. Although we know the expenses for our building, the one next door is about 10 years older and has different equipment. Is there any reliable way of estimating what the expenses are as a percentage of gross

rental income?

A: No. Expenses vary widely from building to building, depending on which costs the tenants pay and which are paid by the owner. The only reliable way to determine expenses and income is to make your purchase offer contingent upon your inspection and approval of the seller’s Schedule E income tax returns for the property for the last three years.