Co-owned rental property sale: how to split depreciation recapture

[nardog]

My wife sold her home that was used as rental property for 4ish years. The property was owned by my wife and her dad. The rental income (100%) was claimed by my wife on our joint return for past 3 years.

-Purchase price (in 2008) = 165K

-Selling price (in 2019) = 170K (doesn’t include 10K spent in closing costs)

-Net selling price = 160K (170K-10K)

-Depreciation (approx. 40months) = 20K

-Adjusted cost basis = 145K (165K-20K)

-Net gain = 15K (160K-145k)

I know that since the property was rental and fails the residency test (rented out for approx. 3.5yrs in last 5yrs), there is capital tax and depreciation recapture due. Since gain is less than the depreciation, 15K should be taxed at 25% max in this case (i think).

However, the settlement agent issued two 1099-S splitting the gross proceeds 50/50 between my wife and her dad. I am wondering how to go about doing our joint return in this scenario? Should I just split everything 50/50 including purchase price, selling price, closing costs, depreciation, etc which would mean we (my wife and I) will pay tax on half of depreciation recapture and her dad will do the same for the remaining half. He is retired with less income so I believe he might be taxed at 12% on the depreciation recapture.

OR should I request the settlement agent to issue a new 1099-S with 100% proceeds from sale in my wife’s name.

Thanks in advance.

[TomYoung]

For clarification, was your wife claiming the net rental income after depreciation during this time?  And, how did Dad and wife become co-owners?

[Carl]

The 1099-S only shows gross proceeds distributed, and that's it. For depreciation recapture, the person who took the depreciation *MUST* recapture every penny of that depreciation they took. So if dad did not report any rental income/expenses and take depreciation, then dad has no depreciation to recapture. The daughter recaptures all of it, assuming she took all the depreciation in the first place.

 If dad did not receive any of the proceeds from the sale, then the daughter will report both 1099-S forms on your joint tax return. Note that there is a selection where she can select that she is not the named recipient on the 1099-S.

[nardog]

Yes. She was clamining the net rental income after depreciation.

She bought  the house when she was 22 so she the dad was co-owner to help her get good rate.

[nardog]

Ok that makes sense.

So, as the dad did not claim any depreciation/rental income, should he still report the proceeds on his 1099-S in his return and then remove them under the rules for a nominee receiving income that wasn't theirs.

Alao, i thought that it doesn't matter who "claimed" the depreciation (on Schedule E) because it needs to be recaptured (irrespective of whether it was even claimed in the first place).

[Carl]

i thought that it doesn't matter who "claimed" the depreciation (on Schedule E) because it needs to be recaptured (irrespective of whether it was even claimed in the first place).

You're almost right. It most certainly does matter who claims depreciation. Basically, one is required by law to take depreciation on business property. (rental property is just another type of business property). Then upon the sale or other disposition of that property, all prior depreciation taken is required to be recaptured and taxed in the year of sale or disposition.

If depreciation was not taken, then the seller is required to recapture the depreciation they "should" have taken, and pay tax on it. Basically the way that's done is that the cost-basis of the property is reduced by the amount of depreciation that "should" have been taken.

[Hal_Al]

Your wife needs to claim the entire sale (100%), on your return, and all the depreciation recapture.

It's her father that has a "tax problem", dealing with the 1099-S that he received. He will claim it on form 8949, then take a "nominee adjustment", reporting 0 net capital gain.  He will show nothing about depreciation recapture.