Is allocation of Sale of Business Property among land, building and improvements necessary?

[SuzyQ727]

After recording the sale of my rental property on Form 4797, Sale of Business Property) and Form 8949 (Disposition of Capital Assets) all of my depreciation is being recaptured on Line 14 of 1040, as I expected, but I didn't allocate the sale among the land, building and improvements. Is it necessary to record this allocation? I thought it was OK to record the sale of land and building as one disposition.

[KrisD15]

Yes, it is needed for the following reasons. 

If you have more than one asset listed (and you would have at least two, building and land) you need to allocate the sales proceeds between those assets in order to get the assets "off the books" and out of your TurboTax program. 

If you made a profit on the land, which is never depreciated, that gain would be a Capital Gain, not Depreciation Recapture. Capital Gain and Depreciation Recapture are taxed differently. 

[SuzyQ727]

First of all, the assets have not been "on the books" since I started using TurboTax. It is a sale on a property that was retired from service (consider the business as "closed") many years ago. Furthermore, if TurboTax keeps a disposed property "on the books," then maybe I need to look around for another tax program that doesn't do that.

Secondly, the capital gain on the land IS recorded, as is the full depreciation recapture. I don't even know how one would NOT record the capital gain on the land if the entire sale is recorded on Form 4797, Lines 20 through 24.

Maybe my question isn't clear but, I don't know how to interpret your answer. I think I just need someone to tell me if I'm still paying the proper amount of taxes by not allocating the sale, rather treating it as one disposition. Or, if it will raise a red flag. Many CPA websites claim that the allocation can be avoided by a single disposition of the property.

@DianeW777 where are you?????

https://ttlc.intuit.com/community/user/viewprofilepage/user-id/2903090

[SuzyQ727]

This subject is also discussed in this post, but it is from 2020 and I don't know if TurboTax updates have made any difference in the answer given by @M-MTax who says the following: "...it doesn't matter whether you allocate to land or not....the whole thing comes out in the wash anyway where your entire depreciation deductions you took or should have taken are recaptured."

https://ttlc.intuit.com/community/investments-and-rental-properties/discussion/when-selling-a-rental...

[M-MTax]

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@SuzyQ727 wrote:

answer given by @M-MTax who says the following: "...it doesn't matter whether you allocate to land or not....the whole thing comes out in the wash....

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It doesn't matter provided you have the exacts sales price, basis, and accumulated depreciation (not that this is not an issue for TurboTax, depending upon how the transaction is entered).

[SuzyQ727]

Thank you @M-MTax. I am confident that I have the exact input numbers, but I had to verify everything in the final printout of the 1040/Schedule D/8949/4797. It indicates that I'm paying ordinary income tax as a result of the depreciation recapture and capital gains tax as a result of the profit from the remainder, although I still don't fully understand the rationale behind the process of allocation as it relates to the sale of a real property.

[M-MTax]

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@SuzyQ727 wrote:

I still don't fully understand the rationale behind the process of allocation as it relates to the sale of a real property.

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Well, if you went out and bought a property, for example a house on a lot, for rental purposes and paid a total of $500,000 for it, you would need to allocate part of the $500k to the house and part to the land. The reason for that is land is not depreciable but the house is, so you have to arrive at some sort of split.

If, further, you determine that of the $500k total you paid, $400k is for the house and $100k is for the land, then your depreciable basis is $400k (but your total basis is still $500k). 

If you later sell the property for $600,000, you would allocate part of that sales price to the house and part to the land. Since you allocated 20% to the land when you bought the property, you could allocate (if nothing has changed), 20% of the $600k ($120k) to the land and the rest to the house.

Nothing much changes in the above scenario because you still have to recover depreciation deductions and pay capital gains tax on the balance (on the house and land).

[SuzyQ727]

I re-read the instructions for Form 4797. First of all, the statement that addresses SALE allocation is under the heading, Special Rules. I don't think that it's necessary to allocate the sale when you already know (as you already said) how much you depreciation you took on the sale of a rental property consisting of a single building on a piece of land. The purpose of allocating the SALE is to determine how much depreciation you took when selling multiple assets. For example, you purchase a building on a piece of land, develop that into a business by adding accessory buildings and equipment such as sheds or garages (that may or may not be used in the business) and then you sell it as a whole in one transaction. Because the buildings and equipment were put into service at different times and may have been subject to different methods and periods of depreciation that may have been complete or partial, you would need to allocate. Because allocation falls under Special Rules, I really don't think that SALE allocation is required in the typical case where a homeowner converts his primary home to a rental property and then sells it somewhere down the road. Fortunately, CPAs have found this special rule useful to them and they have used it as a loophole in order to get their clients better outcomes. This is demonstrated in cases where the FMV land-to-building ratio thus, the depreciation ratio, changes over time and with different market conditions. I'm not even going to try doing that, 'cause I'd be the one to get audited.

[M-MTax]

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@SuzyQ727 wrote:

 This is demonstrated in cases where the FMV land-to-building ratio thus, the depreciation ratio, changes over time and with different market conditions. I'm not even going to try doing that, 'cause I'd be the one to get audited.

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Yes, but the issue there is the change in ratio, where the land becomes more or less valuable over time, would not change the depreciable basis for the building and whatever is depreciable that was built on the land.

[SuzyQ727]

Ok, got it... thanks very much!

[Mike9241]

you may need to allocate sales proceeds to each separate asset and indicate a disposal date. Failure may result in the cost and accumulated depreciation not being taken into account when determining overall gain/loss.

example. You buy property for $1,000,000, allocating $800,000 to building and $200,000 to land. You sell for $1,500,000 and list the entire sales proceeds on the building. Let's also assume depreciation on the building was $100,000. Your gain is is $600.000, but because no sales proceeds were allocated to the land. TutboTax thinks you just sold only the building for $1.5M, resulting in am $800K gain  [$1,5M - ($800K - $100K) ] 

[M-MTax · Accepted solution]

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@Mike9241 wrote:

example. You buy property for $1,000,000, allocating $800,000 to building and $200,000 to land. You sell for $1,500,000 and list the entire sales proceeds on the building. Let's also assume depreciation on the building was $100,000. Your gain is is $600.000, but because no sales proceeds were allocated to the land. TutboTax thinks you just sold only the building for $1.5M, resulting in am $800K gain  [$1,5M - ($800K - $100K) ] 

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That hypothetical is based on having entered a basis for the land previously in TurboTax.

Again, provided the correct sales price, basis, and accumulated depreciation are entered, the program will make the correct calculations in terms of capital gain and Section 1250 recapture. The key here is that ONE piece of property is being sold, not just the building or the land. They don't need to be separated as long as the figures are entered correctly.

[SuzyQ727]

Purchased home. Rented home. Figured depreciation on Tax Assessed value (locality used FMV) of the building, which was lower than purchase price at the time. Building was fully depreciated over years of business use. No capital improvements were made (ONLY repairs were made) during years of business use. Used TT to record Sale of Business Property. Final printed tax return Form 4797 results indicated on: Line 20-Gross Sales Price, Line 21-Cost or other basis plus expense of sale, Line 22-Depreciation (or depletion) allowed or allowable and Line 23-Adjusted basis. Subtract line 22 from line 21, Line 24-Total gain. Subtract line 23 from line 20. And, on 1040, all the gain from 4797 that is subject to capital gains tax and all the depreciation from 4797 that is subject to ordinary income tax is recorded. In this case, TT did it right.  I didn't allocate anything, because it doesn't make any difference if it is as simple as my circumstance. You will see the same result if you perform a test on TT Sale of Business Property. As @M-MTax says: "...it doesn't matter whether you allocate to land or not....the whole thing comes out in the wash anyway where your entire depreciation deductions you took or should have taken are recaptured."

[M-MTax]

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@SuzyQ727 wrote:

 I didn't allocate anything, because it doesn't make any difference if it is as simple as my circumstance. 

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Exactly correct!