Kate bought residential rental property for $500,000. She reported a total of $100,000 of straight-line depreciation. Kate sells the building in 2018 for $425,000. What are the immediate tax consequences of the sale? (Do not consider Kate's other transactions).
I.If Kate's rental activity is a production-of-income (investment) activity, she will report a $25,000 long-term capital gain.
II.If Kate's rental activity is a trade or business, she will report $25,000 of Unrecaptured Section 1250 gain.

Question

Kate bought residential rental property for $500,000. She reported a total of $100,000 of straight-line depreciation. Kate sells the building in 2018 for $425,000. What are the immediate tax consequences of the sale? (Do not consider Kate's other transactions).
I.If Kate's rental activity is a production-of-income (investment) activity, she will report a $25,000 long-term capital gain.
II.If Kate's rental activity is a trade or business, she will report $25,000 of Unrecaptured Section 1250 gain.
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Quizplus · Accepted Answer

Since Kate reported depreciation on the rental property, it must be considered a business or trade activity. Therefore, statement II is correct. The sale results in a $75,000 loss ($500,000 basis - $425,000 sale price), but since she claimed $100,000 in depreciation, she has to recapture some of the depreciation as ordinary income. The unrecaptured section 1250 gain is the amount of depreciation that exceeds the straight-line depreciation that would have been allowed, which is $100,000 - ($500,000/27.5 years x 3 years of ownership) = $25,000.

Kate Bought Residential Rental Property for $500,000