In our last article we talked about the alternative minimum tax item, resulting from the depreciation of commercial or rental property. A direct corollary to that problem is the AMT element that results from any subsequent sale or other disposition of said property. To minimize a taxpayer’s AMT it is essential to understand the relationship between these two elements.
When a property is disposed of, the taxpayer calculates the gain 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 is all that is needed. This same concept also applies to the sale of commercial or rental property, but with one important difference: depreciation. In the case of depreciable property, the tax base is the amount originally paid, but later reduced by any depreciation taken.
The tax base of 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 basis for this machine was $3,600 ($10,000 less the $6,400 total depreciation taken).
What would happen if the machine were sold at this point? The same basic principle of calculation of the difference between the sale price and the tax base is applied. Assume, for example, a sale price of $5,000. In this case, the taxpayer’s profit would be $1,400 and this amount would be included in the taxable income. This is the treatment of the Regular Tax.
The AMT item arises at the time of property sale because, in general, a taxpayer uses a different depreciation method for Alternative Minimum Tax purposes than the one used for Regular Tax purposes. To the extent the taxpayer has these AMT items from differences in depreciation in prior years, the tax base for that property similarly is 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 when calculating profit or loss is a reversal of past AMT-regular tax depreciation differences.
Continuing 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 for $5,000, the taxable gain 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 computation of the taxpayer’s Alternative Minimum Tax. 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 out of every 14 AMT taxpayers has this item, so it is important that both the Alternative Minimum Tax base and the Regular Tax base on depreciable assets be duly calculated. Incorrect calculations can have the effect of negating other AMT planning a taxpayer may have accomplished, costing actual tax dollars.