Calculating capital gains when selling primary residence used for home-based business

[MIsaak]

Hello,

My wife and I have a small S-Corp cleaning business that we have run out of our primary residence since 2002, and we are thinking about both closing (not selling) the business and selling the house in a couple of years.  Consequently, I have started looking into what my capital gains tax might be when we sell, but I am unclear as to how to calculate it (I realize it would purely be an estimate).  I called the IRS, but they no longer help with this type of question, so I was hoping someone might be able to please provide some insight.  Thank you

The home was purchased in 2002 for $128,000 (I haven't yet looked up what additional taxes and fees were involved since I understand they would be added to the purchase price).

We use around 35% of the home for the business, and we are the only two shareholders.

I understand that the current law allows for an exclusion from profit up to $500,000 for couples filing jointly.

By the time we sell, we will have probably put about $50,000 over the years into replacing the roof, guttering, flooring, garage doors, two heat/AC systems, one water heater, and one hot water on demand although I probably no longer have receipts for most of it since much of it was done around 2005.

The total depreciation we would have reported over the years on Form 8829 "Business Use of Home" would be about $21,000.

The portion of the electricity, gas, phone, and internet utilities used for the business are paid using personal expenses and then recorded as shareholder loans to the business (this is how an accountant did it for me way back so I just continued it).  However, the loans are never paid back because the business doesn't earn enough.  The impact of this is reflected in the Schedule K-1s that are then used when processing personal taxes. (The business is now so small that it always operates at a loss so the Schedule K-1s are negative which actually does benefit our personal tax refund, but I can't simply close the business because the income helps).  If the un-reimbursed shareholder loans given to the business to account for utility costs should also be taken into consideration, then those will have totaled at least $75,100 by the time we sell the house.

I estimate we might be able to sell the home for about $190,000.

If I want to have an idea what tax I might have to pay when we sell the home, how should it be calculated?  Is there any other information that also needs to be included?  Thank you very much for any help you might be able to provide.

[JulieS · Accepted solution]

When you sell a property that was depreciated, you must recapture the amount of the depreciation you took, up to the amount of the total gain. That amount is taxed at ordinary income tax rates and is not eligible to be excluded. 

Here is how your transaction will look using the figures you supplied:

Purchase price            $128,000

Improvements             + $50,000

Depreciation                 - $21,000

Adjusted basis             $157,000

Sales price                                        $190,000

Less adjusted basis                           $157,000

Gain on sale                                       $33,000

Gain taxed as ordinary income         $21,000

Amount eligible to be excluded         $12,000

[MIsaak]

Thank you so much.  I greatly appreciate the help.

[gpupala]

Your review is appreciated!  Question:  If the business is closed two years before the home is sold, do the business deductions from prior years still have to be accounted for?

Thanks, -- George --

[KrisD15]

Yes, ALL depreciation needs to be recaptured (claimed) and taxed.