follow up question about selling a two family

[aspielmansir]

Hello everybody thank you for answering this question pretty well I now have my own sale to ask about.

My father sold a legal to family that was purchased in 1973 good luck to me in finding the exact basis.

I'm pretty familiar with the process but I do have some specific questions

1

The units are not the same size luckily if my father the rental Bill unit is only 35% of the entire house because the first floor is attached to my father's house as a mother daughter and it's not rented.

Only the third floor is a rental and yes it is been reported and depreciated.

The most important question is am I allowed to split this 65-35% because splitting in a half would result in a much bigger tax bill.

2 want to verify that my father is entitled to the full $500,000 exemption on the part of the house that was used to live in for the last 40 years and yes he's married.

3 am I correct that before we split things up we adjust the basis by adding all the things that were not depreciated or claimed as an expense on the rental. Also when determining the profit made we first deduct the commission legal fees and direct expenses incurred selling the house for example we had to hire an architect  for $10,000

4 once this is done am I correct that I compute the profit from each portion separately and prorate 65 percent to resident part and 35 to rental.. the residential part would get the $500,000 exemption.

5 am I correct that that only then I would take all of the depreciation that was taken off the rental property and count that as recapture income..yuck!!! But then of course add that to the basis of the 35% commercial part.

6 finally I understand the concept of recapturing the depreciation which includes the portion of the original sale price from 1973 plus roof work or anything that was depreciated but what about expenses that were taken on the rental unit like plumbing fixing? Are those simply ignored?

I realize this is a lot to ask but I appreciate any guidance you can give again I understand the concepts I'm just trying to get these exact details!!

[NCperson]

@aspielmansir - a couple of questions . comments that I think will let others provide a better answer than I could

1) while I understand the 65% / 35% split reasoning, what was the basis of the depreciation decision years ago?  What percent of the house was depreciated over the years.  For example, if 50% of the house value was depreciated over 27.5 years, how do you rationalize a decision to change it now to 35%? (or was the decision years ago to only depreciate 35% and you are now asking is that defensible?)

2) for the cost basis, it should be rather easy to check with the county deed office to determine what the sales price was in 1973.  The improvements along the way may be the challenge. 

[aspielmansir]

Thank you for the quick reply we will have to look at the tax returns to get the exact portion that was used to depreciation for my father's sake I hope it was 35% it but it is what it is

Probably the most important question I have is is my father entitled to the full $500,000 exemption from the residential piece whatever the percentage of the houses I've read many places that he is that I've also seen someone post that he's only entitled to the percentage at that residential is of the whole property if that's the case again that's a bad hit but again it is what it is just want to know the law

[NCperson]

@aspielmansir - just so the facts are clear, let's add some numbers to the question

1) your father and his spouse lived in the house as their primary residence for 2 of the last 5 years of ownership (well, half the house as it was a duplex)... you keep referencing only your father, but just want to be sure there is a spouse involved who also lived in the home as their primary residence for 2 of the last 5 years of ownership.  

2) let's say the home sold for $700,000 with 65% of that allocated to the residence side, or $455,000.  The home was originally purchased in 1973 for $35,000 and 65% of that is $22,750.  For simplicy there were no improvements over 50 years and there were no selling costs when the home was recently sold.  The profit on the residential / primary side was $422, 250.  That is less than $500,000. 

3) On the rental side, it's more complicated due to depreciation recapture, etc. but that isn't your question.

[aspielmansir]

Thank you very much for the response yes my father is married and has lived in the house married for 50 years

The reason why I'm even asking these questions is that somebody panicked me and said that he's not entitled to the full $500,000 because a portion of the house was used for rental

This contradicts everything I've heard but I was trying to confirm

I realize that even though the rental is only 35% of the space I need to check what percentage was actually depreciated a

nd use that percentage to be consistent

[NCperson]

@aspielmansir - you may want to read IRS Publication 523

on page 13, it begins with: 

Business or rental usage calculations. Business or rental space that is separate from the living area affect your gain/loss calculations. Examples of space not within the living area include a first-floor storefront with an attached residence; a rented apartment in a duplex; or a working farm with a farmhouse on the property. If you have used part of the home (not within the home’s living area) for solely business or rental purposes for more than 3 of the last 5 years, you need to make separate gain/loss calculations for the business and residence portions of your property. 

And I think that is what you were going to do: make separate gain/loss calculations for the business and residence portion of your property

https://www.irs.gov/pub/irs-pdf/p523.pdf