Real Estate Depreciation Recapture (ERAT)

In calculating the tax portion of the ERAT figure, what do you do with a loss? Do you multiply the amount of the loss by the tax rate on recaptured deprecation and add as part of ERAT (as a credit to ERAT)?

Please help! An example follows. Thanks

Imagine the following hypothetical question:

Marginal tax rate: 30%

Tax on recaptured depreciation: 35%

Sale price: $45,000,000

Selling costs:

Net sale price: $41,850,000

Purchase price: $50,000,000

Accumulated depreciation:

Net book value: $43,750,000

Net sales price - net book value = $41,850,000 - $43,750,000 = loss

How do you treat the loss as part of ERAT?

I would think at that point it becomes like any other asset you’ve sold - you’ve taken a loss on it. You’ve sold it for less than book value.

If you buy a plant for 100, take 20 in depreciation on it, and sell it a year later for 90, the gain is 10. You’re taxed on the capital gain over book value. If you sell it for 70, you’ve taken a loss on it and it deducts from taxable income. If you sell it for 110, 20 is taxed at recaptured depreciation and 10 is taxed as a capital gain.

This is different from a typical investment in that you’ve taken depreciation on it. Your original cost is the “basis” (ignoring improvements, etc), which depreciation is calculated off of. If you sell it for more than the basis, but have also claimed depreciation on it, you need to reverse the effects of that and pay taxes.

I think you add +$4,632,500 for tax effect.

Take 100 eqpt with book value 50. You sold it for $40.

So loss on sale = $10. When you flow through IS. You will capture the tax shield in your cash flows @ marginal tax right?.

So your ERAT would be $40+$3(30% marginal tax)=$43.

So in this case it should be

Net proceed from sales + tax shield due to loss

$43,750K + $570K = $42,420K

Correct me if wrong

I don’t remember doing question when property was sold at a loss.

Anyone came across any and would like to share?