Home Sale - Refuse 2021 depreciation to reduce capital gains tax

[PeaceBLove]

We sold our house in 2021.  We used it as a rental for part of the year but are able to claim it as our primary residence for at least 2 of the last 5 years (also required to move due to military reassignment, so we get the extra 10 years for exclusion purpose).  When I did my 2018-2020 tax returns, I followed the prompts in TurboTax Premier to apply the depreciation for the rental property. 

However, now that we sold the home, I am working through the capital gains process.  I'm now learning that even if I meet the exclusion rules for selling the home as a primary residence, I will have to pay capital gains tax on depreciation I claimed over the time it was a rental property.  The depreciation in 2021 does not impact my income values as significantly when compared to the amount it adds to my capital gains (i.e., I would pay a much larger tax on 2021 depreciation as a capital gain than I would if I didn't claim it in as a rental expense and paid the extra income tax).  Yet when I work through the asset information on the home as a rental property, TurboTax Premier forces me to to take the depreciation, because if I don't it removes the home sale and eliminates all previous depreciation from the calculations.  How do I refuse claiming depreciation in 2021 on this property, but still work up the home sale worksheet and include 2018-2020's depreciation to calculate my capital gains?

[ColeenD3 · Accepted solution]

You do not have the option of removing the depreciation. It is considered to be allowed or allowable and must be a consideration in rental property. Even if you never took it, you would still have to recapture it. The fact that at one point it was your primary home, does not change this. Having a military exclusion does not change this either.

[PeaceBLove]

Thank you for the reply.  It's unfortunate a homeowner isn't afforded the option and have to pay for depreciation tax even if they didn't gain any benefit from the depreciation. 
Nonetheless, as I was looking more in depth at the details of how the tax is applied, I now think that even if I could exclude the depreciation in the rental income section, it would not make as big a difference as I originally thought.  I mean, every little bit would help, but may as well take the hit and press.

[DMarkM1]

Since you are only working with one year of depreciation, you are correct, it should pretty much be a "wash."  Your rental income will be reduced by the depreciation and your gain on the sale increased by the depreciation.  If the depreciation wasn't a factor at all you would be in the same place, no reduction in income and no gain on the sale.  

[jacs810]

I don't think it makes sense, to override the already covered capital gain by the exclusion.

Going over the TT worksheet (Part IV, Exclusion and Taxable Gain):

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30  Depreciation allowed or allowable on the property for periods after May 6, 1997. If none, enter -0- 30
31 Subtract ln 30 from line 7 above (not less than -0-)

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So TT is trying to reduce the capital gain by the depreciation amount (X) on line 31.

But then it puts taxes back on the depr. amount X:

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38 Taxable gain. Subtract line 37 from line 7 of Part 1. Report any gain on
Sch D. If the amount on line 30 of this worksheet is more than zero,
complete line 39.

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So basically, it is the second iteration of computing the taxes on the capital gain and making the exclusion irrelevant. The exclusion, if high enough to remove any capital gain, why the capital gain shows up again? 

I think it is a grey area,( to say the least). The CPAs in TT are not competent to answer questions like that. The result is that most people land up taking a more conservative path.

[jacs810]

The problem comes when you have an exclusion high enough to override the capital gain.

[Carl]

Basically, you're paying taxes on the recaptured depreciation, as it is not included as a part of the exclusion. Rental expenses may reduce the taxable amount, but it has no effect on taxation of the capital gains from the sale that may exceed your exclusion amount.