Calculation of Basis

[jainen]

Let's say you buy a livable but dilapidated house on a nice lot for $250,000. The land value is appraised at $150,000. You spend $20,000 to tear down the old house and $400,000 to build your dream home, but financial problems force you to rent or sell it. The best offer you get is $650,000. If you accept, what is your gain or loss? If you rent it, what is your depreciable basis?

[rfassett]

Assuming arms length transactions and all of that and that this is the taxpayer's primary residence, your capital loss would be a non-recognized $20,000 on sale; or your rental basis would be $650,000, or the lower of cost or fmv at the date placed in service. If an investment property and never intended to be the taxpayer's primary residence, then the answers would be different.

[ILLMAS]

If you rent wouldnt this be your basis:

Land 150K FMV

Building 100K

Demolition. 20K

Construction 400K

So your depreciation basis would be 520K.

[rfassett]

I don't think so. The basis would be the lower of cost or market at the time of conversion. Since costs were $670,000 and the market value, theoritically (I would want to see an appraisal), is $650,000, I believe it would be $650,000.

[Bart]

rfassett, Jainen asked what your depreciable basis would be. I think your $650.000 figure includes the land which is not depreciable.

[rfassett]

And of course, you are correct. I was quoting the total basis. The depreciable basis would be something less than $650,000 but we have no idea, given the facts, what that number would be - assuming there was some significant time lapse between the original purchase and the demolition of the old house and construction of the $400,000 new house. The $150,000 FMV of the land at time of purchase is immaterial in a period of volatility in the real estate markets.

[BulldogTom]

IF (note the caps on IF) the purchase was made with the intent to demolish the home, the purchase price should be allocated to the land. The 20K of demolition costs would be added to the land in order to make it servicable for the new structure. New construction would be allocated to the home (provided that all the demo costs put the land in position to build on). Basis of the land is 270K and basis of the home is 400K. Depreciation for rental purposes would have to be determined at time it was placed into rental service. Lower of FMV or 400K. If sold, we would need to know the intent of the buyer at the time of purchase. IF it was purchased with the intent of building a personal residence, 20K non-deductible personal loss. IF it was purchased with the intent of building a home for immediate sale as an investment, 20K loss deductible as an investment loss.

IF I knew more, this would be my humble opinion.

Tom

Hollister, CA

[mcb39]

I suppose this is a trick question, but I would say that if you sell it, you have a $20,000 loss. If you rent it, your depreciable basis would be $520,000.

[Pacun]

The depreciable basis is $500.

[Max W]

I think that there is a trap here. The tax appraisal may or may not reflect the FMV. Every county has its own way of appraising and it may be dollar for dollar or it may be 50% or any other percentage that the assessor uses.

Since the house was torn down, I don't see that it had any value. "Livable" is subjective and I have been in some lived-in places that most persons would not want to live in.

So, the cleanest approach to this is that the land is $250K plus the $20K demolition, or $270K.

The basis of the house is $400K.

So, right now there is a $20K loss, but in a year or two that may turn into gain, if it is in the right area.

[ILLMAS]

Land and Buildings

If you buy buildings and the land on which they stand for a lump sum, allocate the basis of the property among the land and the buildings so you can figure the depreciation allowable on the buildings.

Figure the basis of each asset by multiplying the lump sum by a fraction. The numerator is the FMV of that asset and the denominator is the FMV of the whole property at the time of purchase. If you are not certain of the FMV of the land and buildings, you can allocate the basis based on their assessed values for real estate tax purposes.

Demolition of building.   Add demolition costs and other losses incurred for the demolition of any building to the basis of the land on which the demolished building was located. Do not claim the costs as a current deduction.

Modification of building.   A modification of a building will not be treated as a demolition if the following conditions are satisfied.

75 percent or more of the existing external walls of the building are retained in place as internal or external walls, and

75 percent or more of the existing internal structural framework of the building is retained in place.

  If the building is a certified historic structure, the modification must also be part of a certified rehabilitation.

  If these conditions are met, add the costs of the modifications to the basis of the building.

[kcjenkins]

Tom has it exactly right.

[Pacun]

Jainen, you have the right one among those answers. What's your answer?

[jainen]

>>the right one<<

I agree with KC. Except that the intention at time of purchase is irrelevant. As mas quoted, demolition costs "and other losses" are added to the basis of the bare land in any case. You can't rent out a building you no longer have, so depreciation is not allowed. But I wonder if it counts as acquisition cost!

And I also wonder--actually, what I started this for--if you just replace the roof instead of the whole structure, what do you do with the basis of the old roof which can no longer be included in the home's basis?

[kcjenkins]

Well, I'd be inclined to say that if you buy a house that has to have the roof replaced immediately, the old roof would have a very minimal basis, if at all. It's like a case where you buy a wrecked car for parts. You assign most of the cost to the parts you salvage, with only scrap value to the rest of it, right?

[BulldogTom]

Or what do you do when you buy a heavy duty truck and take the original bed off so you can put on a specialized bed. The old bed is scrap metal and that is all to you.

Tom

[jainen]

>>that is all to you<<

That's the practical answer, but not technically correct. FMV is supposed to be an objective standard not related to a specific buyer. Now, suppose you put on that specialized bed with added basis and six months later they come out with the new version that is thinner and has a choice of colors and a hands-free dock for your iphone? When you remove the first replacement, you have to remove its basis too, right?

[kcjenkins]

Now you are changing the question, Jainen. No one disagrees that if you bought the truck intending to use it 'as is', and then you later modify it, you add the new cost of the modification, but reduce by the value of the old part. Which might have some significant market value, or might just be it's value as scrap. The timing is not really the issue, except that when the modification takes place immediately, that supports the position that the part replaced was not a significant part of the value you paid, when it comes to how much should be assigned to that part.

But that was not the question you posed. You originally said "Let's say you buy a livable but dilapidated house", then you said "if you just replace the roof instead of the whole structure, what do you do with the basis of the old roof ". To that I replied "if you buy a house that has to have the roof replaced immediately, the old roof would have a very minimal basis, if at all. " Do you disagree with that? And also, if you replace a roof several years later, you still don't have any significant amount to reduce, IMHO, because the value of the old roof is just the value of scrap, if there is any value at all. Which I doubt. I've never seen anything done with the old roofing except throwing it into a dumpster so that it can be hauled off to the dump. What possible salvage value could it have?

At least with the truck example, used vehicle parts do often have some value, but it's also an easy value to ascertain, you just call a few salvage yards, and take the best offer you get, and that clearly establishes the FMV. Sometimes, when you do something like put on a special bed, the company that sells the special bed will take the other bed, if in good condition, as an adjustment [trade-in] to the price of the new. Again, that gives you a FMV to use in determining the amount of the adjustment to book-value.