Special Assessment as capital improvement while selling condo

Question

I'm selling my primary residence (which I previously rented for two years) and I'm trying to avoid unnecessary recapture on the depreciation. The exact details of my situation are as follows (numbers are made up but give the idea).

1. The initial cost basis for the house (based on purchase price, etc.) was $275,000.
2. After the two year rental period, this was reduced to $255,000.
3. I am now selling the house (FSBO) for $275,000. HOWEVER, the HOA has approved plans to build a new fancy roof. They are expecting to have a special assessment in the range of $20,000 to $25,000 which has not yet been determined. As part of the initial negotiation I agreed to cover those costs for the new owner. In particular, even after depreciation, I will be even or at a loss. The intention was to put 25K into escrow for some period of time (18 Months was proposed?) to cover that special assessment, at least up to 25K.

Now if I could just pay the special assessment before I left I think it would count as a capital improvement and change my cost basis. In particular it would mean that my cost basis is at least $275,000 and so I would not be subject to any recapture with the current selling price. But I don't know how that would work on my taxes with the money in escrow. Given the competence of my HOA, the special assessment could happen before I leave or not for 12 months or so.

My question: Since the contract was just signed and we are now in attorney review, and since I am on the hook for the assessment, is there a way of setting up the contract/escrow in a a way that would help me avoid recapture? I would prefer to just reduce the price, but the board insists that if people sell their condo after they make their decision then the sellers are responsible for the assessment.

Answer 1

My question: Since the contract was just signed and we are now in attorney review, is there a way of setting up the contract/escrow in a a way that would help me avoid recapture?

Are you planning to give the buyer extra $25K to avoid recapture, or are you asking how to frame your commitment so that recapture is avoided, but you're already on the hook for the money?

If it's the former - then I don't understand the math. Your depreciation is $20K, so the recapture tax would be $5K - why would spending extra $25K be beneficial? You'd still be losing money.

If the latter - then ask your attorney and tax adviser, which I'm none, but generally it adds to your closing costs and reduces your proceeds, meaning you end up selling at a loss. The fact that it's a future promise may complicate things though, maybe just reduce the selling price and that's it.

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If the board holds you accountable for the assessment, you can lower the selling price and add an indemnification clause there, i.e.: the buyer will pay you back the assessment. That's a risk though since you'll need to enforce the contract against the buyer. On the other hand the board has no enforcement levers against you other than a lawsuit either, so the indemnification clause may help the board just foreclose on the unit instead, as they're supposed to. Talk to a lawyer.

Answer 2

If you have a car sitting in your garage, and the car's worth $25k, and someone says "I'm willing to pay $275k for this house, but only if you leave the car", then they aren't paying $275k for the house, they're paying $250k for the house and $25k for the car.

You aren't selling a house, you are selling a house and an agreement to pay for the improvement. If the FMV of the improvement is $25k, then the buyer is paying $250k for the house and $25k for the improvement. So you should list the sale price of the house as $250k. If the IRS questions it, it would help to have documentation; in the contract to sell the house, make it clear that the sale price is for the house and the improvement.