Primary residence converted to rental property and back to primary residence, then sold in less than 1 year, so we don't qualify for the capital gain home exclusion. I think I know how to report the sale, but I would appreciate confirmation.

[Kayteem]

We purchased a primary residence (Home A) in 2005 and lived in it until 2014, at which time we converted it to a rental property (10/2014). We purchased Home B in 01/2015 and lived in it until 10/2018. Home B was listed for sale and we moved back into Home A 10/2018. Home A was removed from Schedule E in 2018 when we converted the home from a rental to our primary residence. Home B sat on the market until it sold 04/2019. We took the capital gain exclusion for Home B since we qualified. We then sold Home A in 08/2019 knowing we would NOT qualify for the capital gain exclusion. It was our main home at the time of the sale and there were no tenants occupying the home in 2019.

From what I understand, we need to report the sale of Home A in the Sale of Business section, rather than the Sale of a Home section, even though it was our main home at the time we sold.

1. Is this correct that will be reported in the Sales of a Business section?

2. If yes, are the steps listed below correct? It seems too simple. I certainly don't want to complicate this, but the interview does not ask how long the property was used for personal use and business use. It seems like the IRS will notice that we owned the property for 14 years, and be curious why we took depreciation for only 4 years while it was a rental, or worse demand 14 years of depreciation. Or will the IRS see the depreciation taken in our prior tax returns, and know from each schedule E that we rented it for only 4 years?

3. Here are my proposed steps, please review:

Go to Sale of Business
Check Sales of business or rental property that you haven't already reported.
Add Description: <home address>
Add Date Acquired: 07/21/2005
Add Date Sold: 08/16/2019
Add Total Sales Price: 510,000
Add Cost of Property: 401,909 (Purchase price + allowed purchase costs + improvements + selling costs)
Add Depreciation Taken on This Property: 29,679 (~ 4 years SL/MM)
Check the radio button - Real estate that I took depreciation on
No Installment Sales
Yes to 1099-S, Gross Proceeds 510,000

Please let me know if the steps are valid.
Thank you!

Here is a timeline for clarity, if helpful:

2005: Purchased primary residence Home A.
2014: Converted Home A into a rental property.
2015: Purchased primary residence Home B.
2018: Listed Home B for sale. Moved back into Home A as our primary residence. Removed home from Schedule E on 2018 return.
2019: Sold Home B and took the capital gain exclusion. The Home was on the market for the last part of 2018 and into 2019.
2019: Sold Home A. We cannot take the capital gain exclusion.

[Carl]

From what I understand, we need to report the sale of Home A in the Sale of Business section, rather than the Sale of a Home section, even though it was our main home at the time we sold.

1. Is this correct that will be reported in the Sales of a Business section?

Yes. This is because you are required by law to recapture all depreciation you took on that property while it was a rental. You will pay taxes on that recaptured depreication, and it will increase your AGI.

2. If yes, are the steps listed below correct? It seems too simple.

Yes. However, I see many folks that do not recapture "ALL" of the depreciation taken. What you have to do is on the tax return for the last year you rented it and converted it to personal use, you need to IRS Form 4562's. THere are two of them and they both print in landscape format. The primary one you're interested in is titled "Depreciation and Amortization Report".

You need to add up all the amounts in the "prior years depr" column and the "current year depr" column. The total of both columns will be the total amount of depreciation you have to recapture.

Now *BE CAREFUL* because on the first 4562 I mentioned, you may have a section for "amortized costs". Those are "NOT" depreciation amounts. They are flat out deductions. Your amortized costs are deducted (not depreicated) over the life of the loan. Therefore, any remaining amount of amortized costs not yet deducted are added to your cost basis of the property. This reduces your taxable gain accordingly.

I certainly don't want to complicate this, but the interview does not ask how long the property was used for personal use and business use.

Because based on the dates you provided, it's rather obvious you don't qualify for the capital gains tax exclusion. So there's no need to ask.

It seems like the IRS will notice that we owned the property for 14 years, and be curious why we took depreciation for only 4 years while it was a rental, or worse demand 14 years of depreciation.

Perhaps you mistakenly think the IRS doesn't have a complete history of your tax life since you filed your very first return when you got that first job as a busboy? Don't worry about it. I can assure you, they know more about your tax life than you do. 🙂

3. Here are my proposed steps, please review:

Everything is spot on for reporting the sale of Home A.

Here's a quick synopsis of how the program handles the numbers.

You will be asked in the Sale of Business Property for all depreciation taken. That amount is basically added to your sales price. Additionally, that amount will be taxed at a maximum tax rate of 25%. So even though the depreciation arecapture dds to your AGI, if  your tax bracket is below 25% without the depreciation recapture, it will not exceed 25% with the recapture.

If your tax bracket is over 25% without depreciation recapture, Then it will change your "step up" to the next tax bracket by the amount of recaptured depreciation, thus keeping the recaptured depreciation out of the tax bracket above 25%.

[Kayteem]

Thank you, Carl! I appreciate your help and how you answered my questions and added relevant information and tips. I will carefully review the depreciation for each year by adding the 4562 totals (excluding amortization). I think the 4562 numbers should also match Schedule E, line 18 in the Supplemental Income and Loss form for a sanity check.

[Carl]

One thing I just realized I forgot to inform you of. On the 4562, if you took the 50% special depreciation allowance on any asset, that will be shown in the relevant column on the 4562 also. You need to include that in your total depreciation amount to be recaptured also.

I would not expect you to have anything in the SEC179 column, since rental property is not eligible for the SEC179 depreciation deduction. But it is possible (though not common) that you "could" have an asset that actually qualified for the SEC179. If you did, then that amount also has to be included in your depreciation total for recapture.