Does “Rental Use” on Primary Residence Multi-Family Home have to be the same as “Business Use” when I calculate capital gains on the sale?

[Hypno_Pony]

My wife and I sold our home in September, 2019. It was rented out 6 months of 2019 and full time since 2016. Our house was about 1,200 square feet and it had an attached apartment of 600 square feet. In the past, we just estimated our rental use percentage at 33% based on those numbers. This is what a tax professional advised the year we purchased and we have done the same every year since when calculating deductions/depreciation on the income from the rental.

Now that we sold the property, we have to pay capital gains tax on the business portion of our home. Using the rental use proportion of 33% doesn't seem fair as there was a 460 square foot detached garage, a 1200 square foot basement and a large yard/porch they did not have access to. What are considered fair ways to calculate the business use percentage for capital gains? If I go by total square footage of all buildings including the basement (but not the porch), the portion of business use is 17%

Should my rental use calculation for deductions/depreciation match my business use calculation for capital gains in the same year? (33% when calculating rental use and 17% for capital gains)? If they should match, is it okay to change my rental use to 17% even though every year prior I used 33%?

[ColeenD3 · Accepted solution]

No, you should not change percentages at this point. You have taken expenses and depreciation based on a certain percentage. You have reaped that benefit for 3.5 years. 

However, you can go back and amend your prior year returns to adjust the square footage to reflect the more accurate percentage. Once you have made the corrections and paid back any deduction you were not entitled to, then your 2019 return will be in alignment.

Generally, you must file Form 1040X within three years from the date you filed your original tax return or within two years of the date you paid the tax, whichever is later.

[marcjy1]

I have a somewhat related question. I rent one bedroom in my two bedroom house to my qualifying relative niece who is on SSI under a rental agreement on record with SSI. She has full run of my house. The rent is fair rental value.

I thought I could enter 50% as the percentage of the asset used for business purposes given that she has full run of my home. I thought this meant 50% personal use and 50% business purposes.

But, other advisers have stated that the square footage of the room is the business portion of my home. The square footage of the room represents 16% of total square footage of my home.

Therefore, it would appear that Schedule E should reflect this percentage against the various expenses? I realize publication 527 speaks to this, but I want to make sure.

Secondly, should I use 16% instead of  50% as the percentage of the asset used for business purposes?

Thank you.

[ColeenD3]

Yes, if her room is the only room she has exclusive use of, that is your rental property. Common areas do not count.

[marcjy1]

Thank you for responding to many of my queries.

This will be my first Schedule E. 

I rent a room  as I have said earlier  to my qualifying relative niece  and I  provide more than half her support even counting her SSI income.  So I will also file as  head of household.

I previously filed as head of household in 2017 and 2018  when she was living with me, but not paying rent because she was not receiving SSI.  

I wonder if all this will trigger an IRS Notice from the IRS?

[ThomasM125]

The IRS will not know you are renting the house to your dependent, so it should not be an audit trigger. However, you can't treat the fair market value of the room rent as part of the support you are providing, so it may affect your ability to be providing half the support of the individual for the support test.

[marcjy1]

Here is what I have done in that regard.

I used worksheet for determining support, publication 501.

On page 20 of 501, left-hand column, under Fair rental value defined, second paragraph, I am providing the "entire dwelling" because she has full use of my home, even though she is renting one of the bedrooms in my two-bedroom home. It is just her and I in the home.

So, on line 6b of the worksheet, I have entered Fair rental value of my home which then ends up divided in half on line 12.  Or, a 50-50 split between her and me given that we both use the entire home.

So, that is my reasoning based on my reading of the paragraph. I hope that is correct.

[Carl]

So, that is my reasoning based on my reading of the paragraph. I hope that is correct.

Just understand that an individual's "reasoning" doesn't play out well in tax court, should you get audited. If you're claiming 50% as being exclusive to the renter, sooner or later it's going to catch up to you and the fines and penalties are going to be much, much more costly that what you may have "saved" by making your "reasonable" claim. Not saying this will happen. But if you keep this up for say, the next 10 years you can fully expect it to happen.

Remember, while a tax payer can only amend a return a maximum of three years back, the IRS can audit for up to 10 years back, and more if they have "reasonable suspicion" of fraud.  You claiming a paying renter that pays rent to you, as a dependent is more than enough for "reasonable suspicion" from what I see. But then, I don't claim to be a lawyer or tax expert by any stretch of the imagination either. I just want you to be aware of the possibilities here, no matter how slim we think those possibilities are.

[marcjy1]

What is your reading of that paragraph? Because I thought I was reading it correctly and therefore used it on worksheet 2. This was prompted by your statement that I could not use her rental income as part of support. That is why I ask you about that particular paragraph.

[kathyv]

I have a question regarding capital gains for a multi-family property that was lived in as a primary residence for 2 of the last five years before selling.  The property is a 2 family and my son and his family lived in the first floor apartment which is 70% of the square footage of the house.  He has owned the property since 2010 and has consistently rented out at least 30% of the property each year (some years renting out as much as 75% - when he first owned he was single and had roommates that he rented to).  My son purchased a home in 2018 and sold the rental property in October 2020 so from March 2018 until the time it was sold the property was rented 100%.  

How do I enter the sale in Turbo Tax?  Am I entering the sale in the business section or the personal section.  I have gone through the assets and entered that each was sold and when they were sold.  I'm assuming Turbo Tax will then record the recaptured depreciation from this information.  

Currently, I entered the sale of the home in the personal section and there is no capital gains, but I believe capital gains is owed on the portion that was rental only.

[ColeenD3]

This is not reported in Sale of Home, but in the Rental Section, since it was fully a rental the year it was sold. Yes, TurboTax should recapture all the depreciation that was taken through the years.