Sale of rental that qualifies for home sale exclusion

[Futch2010]

I have followed the steps for a sale of a rental that qualifies for home sale exclusion however it is still showing as a long-term capital gain on the Schedule D.  Is this correct?  I thought if it qualified for the home exclusion then none of the gain should roll through the tax return.

[IRonMaN · Accepted solution]

Depreciation recapture?

[Futch2010]

No depreciation taken for the rental

[TaxMonkey]

The person who found this post unhelpful will suffer is a special level of Hell for all eternity.

[IRonMaN]

:laughing:

[abctax55]

"....No depreciation taken for the rental"

Oops.  You need to look into "allowed or allowable" and/or Form 3115 then.

[Just-Lisa-Now-]

and they WILL get you for that!  Former TurboTax user clients are still paying off the IRS bill from when they sold a rental and never took deprecation so they didn't recapture at the time of sale!

[TaxGuyBill]

Oddly enough, the home exclusion CAN cover the unclaimed depreciation.  The unclaimed depreciation still lowers the Basis, but if the gain is under the amount of the allowable exclusion, there would not be any tax.

[Just-Lisa-Now-]

:+1:

[Futch2010]

The gain on the sale is on $21,600 without any depreciation claimed so this should be covered by the allowable exclusion.  Should I "depreciate" the rental and lower the basis?  

[Just-Lisa-Now-]

How long has it been a rental?

[Futch2010]

since 2016

[rbynaker]

"Oddly enough, the home exclusion CAN cover the unclaimed depreciation.  The unclaimed depreciation still lowers the Basis, but if the gain is under the amount of the allowable exclusion, there would not be any tax."

Maybe we're talking about two different things.  You can't exclude the amount of the basis adjustment due to depreciation allowed or allowable.  So there will be tax on the 1250 gain.  See 121(d)(6):

https://www.law.cornell.edu/uscode/text/26/121#d_6

[Futch2010]

Proseries is calculating tax on the difference between the sale and the basis without any depreciation taken.  Still going back to the original question, shouldn't this sale be excluded and not reported on the Schedule D?

[Just-Lisa-Now-]

Did you fill out the HomeSale worksheet then Double click the box on the asset entry worksheet for the rental to the Homesale worksheet?

[TaxGuyBill]

@rbynaker   Read §121(d)(6) again, and then look up the reference to §1250(b)(3).
https://www.law.cornell.edu/uscode/text/26/1250#b_3


@taylor0509   The Basis is lowered whether you claim depreciation or not.  If you did not actually claim depreciation, the Basis is lowered by what you COULD have claimed.

Yes, it is should be fully excluded.  If there isn't a 1099-S, you could even just not enter it.  Otherwise, it seems like you are mientering something on the Home Sale Worksheet.

[Futch2010]

Looks like the depreciation is being taxed even though they did not take prior year depreciation (as it is allowed/allowable).  Thank you for your help!

[TaxGuyBill]

As I pointed out above, the depreciation DOES qualify to be excluded if you did not actually claim it.

I would just enter a lower Basis and say there was no depreciation allowed/allowable.

[TaxMonkey]

I think that is a very generous interpretation of, "if the taxpayer can establish by adequate records or other sufficient evidence that the amount allowed as a deduction for any period was less than the amount allowable, the amount taken into account for such period shall be the amount allowed."

My interpretation is not that depreciation is optional, as you seem to imply, but rather that if depreciation becomes not deductible - for example a home office deduction limited by business profits then you would not need to include it.

[TaxGuyBill]

Hmmm.  You may be right.  I remember reading something that let me to my original viewpoint, but I'm not finding that now (and what I have found supports your interpretation).

[abctax55]

FWIW....I agree with Mr.Monkey on this one  :banana:

[TaxGuyBill]

That's going to bug me now, because I KNOW I read something/somewhere that led me to me original thought, but now it seems likely that was wrong.

[abctax55]

Was it on TurdoTax :smiling_imp:

[TaxGuyBill]

If I read it on TurboTax, I automatically know that it is likely wrong.   :smile:

[IRonMaN]

Magazine in the barbershop?

[rbynaker]

I remember a discussion with Chuck about this several years ago.  Not going to try to find it now though.  I think AM was involved also.

My understanding is those are circumstances such as the business income limitation as Monkey mentioned, or maybe an employee home office that doesn't get over the 2% hurdle (or I guess any employee home office post-TCJA).

Fortunately, we have a fairly relaxed 3115 "get out of jail free" card.  Yes, it's more paperwork but that's the cost of prior year DIY returns (and I'm not afraid to tell clients that).  Nothing is lost, it's just a chore to get it back.

[TaxGuyBill]

What exactly is the difference between "allowed" and "allowable"?

For example, let's say the taxpayer incorrectly claimed too much depreciation.  Is that "allowed"?  Is that "allowable"?  Something else?

[rbynaker]

Pub 946:

Basis adjustment for depreciation allowed or allowable.
You must reduce the basis of property by the depreciation allowed or allowable, whichever is greater. Depreciation allowed is depreciation you actually deducted (from which you received a tax benefit). Depreciation allowable is depreciation you are entitled to deduct.

If you do not claim depreciation you are entitled to deduct, you must still reduce the basis of the property by the full amount of depreciation allowable.

If you deduct more depreciation than you should, you must reduce your basis by any amount deducted from which you received a tax benefit (the depreciation allowed).

[TaxGuyBill]

"Depreciation allowed is depreciation you actually deducted (from which you received a tax benefit)"

Okay, if we temporarily ignore the "from which you received a tax benefit", then my original thought be correct, right?

§1250(b)(3) says "if the taxpayer can establish by adequate records or other sufficient evidence that the amount allowed [depreciation you actually deducted, in this case $0] as a deduction for any period was less than the amount allowable, the amount taken into account for such period shall be the amount allowed"

Right?  That is where my original thought comes from.  That "allowed" means depreciation that was actually taken.  So just from that, the exclusion would cover the depreciation.


As for the "from which you received a tax benefit", I don't remember that.  However, would that necessarily need to be one-way?  By not claiming depreciation, it caused you to owe more tax.  So it isn't a 'benefit' to save taxes, but it DOES affect the amount of taxes (but in a negative way).  Logic would dictate it should go BOTH ways.

Any idea if there is any 'official' guidance in that definition?

[Futch2010]

Ok, so for the record, should I use the amount allowed (actually $0) for depreciation or the amount allowable for depreciation?  

[TaxGuyBill]

@taylor0509   I'm not sure if we have reached a definite conclusion to that.

The 'safe' way to do it would be use Form 3115 to 'catch up' on the missed depreciation, and then for the sale you would report the depreciation that was actually taken (via Form 3115).