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AMT and disposition of commercial or rental property

In our last article we talked about the alternative minimum tax item, resulting from the depreciation of commercial or rental property. A direct corollary of that problem is the AMT item that results from any subsequent sale or other disposition of such property. To minimize a taxpayer’s AMT, it is essential to understand the relationship between these two elements.

When a property is disposed of, a taxpayer calculates the profit or loss based on the difference between the sale price and its tax base. For something like a stock or bond, the tax base is the amount originally paid for the investment, that’s all that is needed. This same concept also applies to the sale of commercial or rental properties, but with one important difference: depreciation. In the case of depreciable property, the tax base is the amount originally paid, but then reduced by any depreciation taken.

The tax base for depreciable property changes every year. In the example in the last item, a $ 10,000 machine was depreciated by taking a deduction of $ 4,000 in the first year and a deduction of $ 2,400 in the second year. Therefore, at the end of year 2, the tax base for this machine was $ 3,600 ($ 10,000 less the $ 6,400 of total depreciation taken).

What if the machine were sold at this time? The same basic principle of calculating the difference between the sales price and the tax base applies. Suppose, for example, a sales price of $ 5,000. In this case, the taxpayer’s profit would be $ 1,400 and this amount would be included in taxable income. This is the regular tax treatment.

The AMT item arises at the time of sale of the property because, in general, a taxpayer uses a different depreciation method for the purposes of the Alternative Minimum Tax than the one used for the purposes of the Regular Tax. To the extent that the taxpayer has these AMT elements due to differences in depreciation in previous years, the tax base of that property is equally different for the AMT than for the Regular Tax. Therefore, the gain or loss on the sale of the property is also different. Essentially, the AMT difference in the profit or loss calculation is a reversal of the regular tax-AMT depreciation differences in the past.

Continuing with the same example, if after two years a taxpayer has been allowed $ 5,100 in depreciation deductions for the AMT (see previous article), the machine’s AMT tax base is $ 4,900. Assuming a sale of $ 5,000, the taxable profit for AMT purposes would be $ 100.

This $ 1,300 difference in taxable profit (the $ 100 AMT profit compared to the $ 1,400 regular tax profit) is an AMT item in the year of sale. This is a favorable adjustment in the calculation of the Alternative Minimum Tax of the taxpayer. It would be entered as a negative number on Form 6251, which would make the Alternative Minimum Taxable Income $ 1,300 less than the regular taxable income.

One in 14 AMT payers has this element, so it is important that both the alternative minimum tax base and the regular depreciable property tax base are calculated correctly. Incorrect calculations can have the effect of denying other AMT planning that a taxpayer may have accomplished, at a real cost in tax dollars.