How to record sale of a rental property which switched between primary residence and rental status (home-rent-home-rent) and use the "Qualified Extended Duty" exemption?

[wmgman]

Background details for home used as both primary residence (twice) and rental property (twice) over a period of 27 years.

Primary Residence 1993 - 2001:
  Original purchase price of $115,000 ($103,500 home, $11,500 land) in 1991
  Lived in home as primary residence until 2001

Rental Property 2001 - 2006:
  Converted to 100% rental property (land and home together)
  5-yr Term Depreciation of $18,819 on $103,500

Primary Residence 2006 - 2010:
  This period used as source 2 of 5 year rule for capital gains exemption while on "Qualified Extended Duty".

Rental Property 2010 - 2020:
  Converted back to 100% Rental property with adjusted basis of $91,316 (Original Basis - Prior Depreciation + Capital Improvement)
  10-yr Term Depreciation of $32,377 on $91,316
  Total Depreciation of $51,196
  House rented until early June 2020

Sale of Property June 2020:
  Qualified Extended Duty from beginning of period through Feb 2018 used to suspend 5-yr test period.
  House suffered significant wear and tear (damage) at the end of the rental period. Using tax documents, land is valued at $92,400 leaving the home valued at $157,600 for the purpose of allocating the sale.

I expect that the sale would trigger re-capture of the total depreciation ($51,196) at 25% rate and that 100% of the sale would be eligible for the capital gains exclusion (married filing joint) as we have never used the exclusion on any other properties.

When working through TurboTax for the sale, I see the following issues which I don't know how to correct:
1. There does not appear to be any place to add in the depreciation for the prior period ($18,819). Shouldn't there be some place to add in this prior depreciation? (Yes, I realize this is a less usual case).
2. The sale is rolling forward as a capital gain of $84,641on 4797 line 7. TurboTax is excluding the land from the 2 of 5 exemption. Is this really supposed to be the case or am I doing something wrong? It was all purchased as one property in 1993 and used/rented as one property throughout.

I can provide more information, but I am not certain what is relevant to the situation.

Thank you.

[ColeenD3]

Q1) After you enter the sale in the rental section, you will encounter a screen that has a box containing prior depreciation. This amount can be overwritten to include the previous depreciation.

Q2) The land should be included. Did you indicate on the proper screen in the rental section that this was your main home? What are you seeing? Is the land showing on Form 4797? Go back over your entries.

[wmgman]

ColeenD3,

Thank you for your response.

Q1) I went back to the "Review Information" page on the property and adjusted the following:

    Cost: added Prior Depreciation back in. I had previously removed this from the basis and added in capital improvements (new roof) when putting it back into rental service in 2010 per guidance I received at the time. Cost went from $ to $121,635 for this property (including land).

    Land: No change - $11,500

    Prior Depreciation: Added 2001-2006 depreciation back in. Depreciation went from $30,855 to $49,674 for the whole period of ownership not including 2020 ($1522).

    NOTE: I got a lot of expert advise when I moved the property from Rental to Primary Residence to Rental again. The consensus was that I should not recapture the initial depreciation until the property is ultimately sold AND I had to adjust the cost basis when renting for the second time to account for prior deprecation as well as starting a new deprecation schedule with the new basis number and the full period (27.5 yr).

Q2) I have answered the questions that record this property as my main home, and I have exemption for profits on the structure. At one point I recall entering the land value at sale ($92,400), but cannot find that point! The land is showing up on 4797 as an individual item in Part I, Line 2 (as well as a Section 121 exclusion of only $82,030). I can find the entry in the Forms section (Asset Wks) on line 24, but I cannot find the question that I answered in the "EasyStep" section. I am assuming that I should NOT have broken out the Land Sales Price as a portion of the total sale. Is this where I messed up? Should I have a form 4797 at all?

BTW, I have used Tax for years to keep all this stuff straight. Handling the conversion of this property has caused me the most headaches on my taxes every year (with a few amendments thrown in for good measure).

[ColeenD3]

No, you should not have a 4797. I don't know why the land is being treated separately, since this is the first time I've seen this. You are supposed to separate out the land, since it is not depreciable. But, for purposes of the exclusion, it should all be one property.

My only recommendation is to delete all of it and re-do it.

[wmgman]

ColeenD3,

Thank you for the information/confirmation. I am starting over ...

Cheers!

[Carl]

@wmgman I see quite a bit of incorrect information in this thread that is going to cost you quite a bit of money tax-wise if you follow it. I suspect that with all the posts the TTX reps read in a day, it's quite easy to miss things. Even if they're obvious. (I'm guilty of that too.) Let me recap, and provide you the correct information.

Rental Property 2010 - 2020:
Converted back to 100% Rental property with adjusted basis of $91,316 (Original Basis - Prior Depreciation + Capital Improvement)

That was correct. That is how you "account for" the prior depreciation already taken.
Q1) After you enter the sale in the rental section, you will encounter a screen that has a box containing prior depreciation. This amount can be overwritten to include the previous depreciation.

That is incorrect. You already accounted for the prior depreciation already taken, when you reduced the cost basis by that prior depreciation already taken, when converted back to rental in 2010. Leave the prior depreciation exactly as it appears in the program.

Later you say "Using tax documents, land is valued at $92,400 leaving the home valued at $157,600 for the purpose of allocating the sale." 

What the tax values are, have absolutely no bearing in in way, shape, form or fashion on your 2020 tax return. You don't need tax values for anything what-so-ever.

Now to your questions (correctly answered)

1. There does not appear to be any place to add in the depreciation for the prior period ($18,819). Shouldn't there be some place to add in this prior depreciation? (Yes, I realize this is a less usual case).

No, you will ***not*** "add in" any prior depreciation from the first rental period. You already accounted for that prior depreciation when you reduced the cost basis in 2010. That in and of itself "accounts" for it.
2. The sale is rolling forward as a capital gain of $84,641on 4797 line 7. TurboTax is excluding the land from the 2 of 5 exemption. Is this really supposed to be the case or am I doing something wrong? It was all purchased as one property in 1993 and used/rented as one property throughout.

My "train of thought" on this indicates that either you and I are not on the same page, or something else is wrong. Understand that your recaptured depreciation is *not* exempt from being taxed under the "2 of last 5" rules. (2 of last 10 in your case). You will pay taxes on that recaptured depreciation, no matter what.

One advantage for you, is that since you followed the IRS rules of reducing your cost basis by depreciation already taken when you converted the property back to a rental in 2010, is that the $18.819 of deprecation taken 2001-2006 is not taxed since it's not treated as "prior depreciation taken" any longer.

[wmgman]

@Carl,

Thank you for your reply.

I went round-n-round with this while doing my 2010 taxes after I put the property back into rental status, so what you say makes sense for what I determined at that time (I did it wrong to begin with and had to amend the 2010 return later that year).

I understand and agree on the Depreciation Recapture (tax) and fully expected that to occur. I paid estimated taxes of 25% of $51,196 to cover this following the sale last year (though it looks like it should have been 25% of $32,377). My fundamental question (after clearing up the prior depreciation issue) is "What should I expect to be Section 121 exempt for this sale?" My gut tells me that it should be: Sale Price - Final Rental Period Basis - Final Period Depreciation - Allowable Sales Expenses with the Final Period Depreciation being recaptured as well. This is because we lived in the house from 2006 through late 2010 when we departed and were on Qualified Extended Duty until Dec 31, 2018. We sold the house almost exactly 1.5 years later. I am working through the Pub 523 to prove/disprove myself, but welcome your insights.

This topic is very confusing (no thanks to my situation) in TurboTax. I can get about a half-dozen different results based upon answers I give which can seem right. For example, one of the T-Tax results had me allocate the sale price between Home and Land. It was treating the Land gains and the Home gains individually and that was causing the Capital Gains tax on Form 4797 for the Land (this is why I was inputing the tax value of the land).

If you don't mind, I have related questions because the dialog in T-Tax is not clear and does not match the Pubs at times:

Following the "Disposition Information" (Sale: 6/26/2020, Acquired: 2/11/1993), the next page is "Special Handling Required?" . Only the first and last lines seem to potentially apply:

    1st: "The business use percentage of this asset varied during the years you owned the asset." To me, this could mean "varied during the years you owned it AS A BUSINESS asset" and the answer would be NO, or it could be "varied during the years you owned it (since purchase)" and the answer would be YES. What is the right interpretation?

    Last: "This asset was a rental, a home office, or a home office improvement within a home". Selecting the "Learn More" give notes about "the portion of the home used as a rental ..." so it makes me think I should read the original statement as "This asset was a rental WITHIN A HOME, a home office WITHIN A HOME, or a home office improvement within a home" and answer NO. Does this make sense?

Cheers

[Carl]

I'm formulating a lot of questions here. Unfortunately, I can't ask them all in one post. That's becuase the answer to one question, determines what the next quetion will be.

Here's what I see:

Rental Property 2001 - 2006: (this period of time counts for nothing)

Primary Residence 2006 - 2010:

Rental Property 2010 - 2020:

Qualified Extended Duty from beginning of period through Feb 2018

So to clarify,

1. You were moved under PCS orders sometime in 2010.

2. You returned to that same location in Feb 2018. Was this return to the same location, under PCS orders for duty? Or separation/retirement?

[Carl]

You get the full exclusion if you lived in the property for at least 730 days (2 years) of the last 1826 days (5 years) you owned it. Days in the suspension period are not counted for the 1826 days of ownership. The suspension period can work out to be any period of time, up to a maximum of 10 years. So lets count back the days from the closing date of the sale. The closing date of the sale is not counted as one your days of ownership. Now with my below I"m going to pick dates out of thin air, in the tax year that applies, since you didn't provide exact dates for me to work with. The specific dates I select also make the math easier on my end. But clear your head anyway, check the air tanks and make sure the regular valve is working correctly. We're going deep.

Date you moved out of the property and departed the area: 7/1/2010
Date you returned to the area and did not move back in : 7/1/2018.
Closing date of sale: 7/1/2020.
First, we have to determine the start date of your days of ownership that applies, and not include in that day count, the days that are excluded.
So the day count from 7/1/2020 back to 7/1/2018 is 731 days (2020 was a leap year)
Continuing the count backwards, and the days from 7/1/2018 back to 7/1/2010 are excluded from being counted as "days of ownership", because those days are the days you were not living in the property because of official orders.
The day count resumes the count backwards in time on 6/30/2010. We can go back from this date a maximum of 1,095 days. That takes us to 7/1/2007.
So your "days of ownership" for determining if you qualify for any exclusion runs from 7/1/2007 to 6/3/2008. Then it resumes on 7/1/2018 up to the date of the closing on the sale. That gives a total of 1826 days (5 years) Here's the math.
7/1/2007 to 6/30/2010 is 1095 days
7/1/2009 to 6/30/2018 are not counted
7/1/2018 to 7/1/2020 is 731 days
Total days is 1826, which equates to 5 years.
Days you lived in the property as your primary residence between 7/1/2007 and 6/30/2010 is 1095 days, of the 730 days required for full exclusion.
Days you lived in the property as your primary residence between 7/1/2018 and the closing date of 7/1/2020 is 0 days.
You have a total of 1095 days out of the 730 days required for the maximum exclusion. You qualify to exclude the total gain up to a maximum of $250,000 if single, and a maximum of $500,000 and married filing joint and *BOTH* you and your spouse lived in the property as your primary residence during the days within the periods of qualifying time.
Finally, remember that you "will" pay taxes on the depreciation you're required to recapture, no matter what. The depreciation recapture is not included in whatever amount of the gain you are allowed to exclude.

[wmgman]

@Carl,

Quick answer to these questions here:

PCS - 8/27/2010

Never moved back to the area (though that was the intent and reason to keep the property in the first place)

Separated at PCS location - 12/31/2018

Purchased replacement Primary Residence on 8/8/2017 (I did not state this before, but working through Pub 523, I think this is really the relevant date. Even if this is not right, using any other date will give a longer occupancy as primary residence).

Counting back from date of sale using Qualified Extended Duty from 8/27/2010 to 8/8/2017 results in 772 days as primary residence and 1054 in rental status.  So, 100% of the gains are allowed under Section 121 excluding the depreciation recapture of $32,377.

Now I just need to figure out how to make T-Tax dance to this tune. The reason I went down this path in the first place is that I did not trust the answer I was getting. I am glad I did not. That you for your solid, example-based analysis of this situation.

Cheers

[wmgman]

@Carl,

This is perfect and coincides with my understanding of the situation before using T-Tax. Unfortunately T-Tax either does not make choosing the right answers to their questions clear, or they don't calculate it correctly. To unravel this mess and try again. I am going to come to the surface, take off the tanks and regulator, blow up this return and start over from scratch to see if I can get the answer I know it should be. If worse come to worse and I cannot get T-Tax to dance, then I will be doing my taxes by hand this year!

If I get it to work, I plan to post a follow-up with the steps taken so it can serve as a reference to others.

Thank you again.

Cheers

[Carl]

Hey, if it comes down to it, just skip all the "exclusion" crap and when asked "did you live in it 24 months of the last 60 months?" just say yes. If audited on it, you've got copies of your orders which have the NLT reporting date on them. In my opinion (and we all know what opinions are like) you have a better chance of having a gnat fly into the back of your head at full speed and knock you down to your knees, before you get audited on this particular item.  (Hey! Never say never! It "could" happen in some other universe!)

[wmgman]

@Carl,

I think you just WON with this answer. I started a new return by importing all the 2019 data and just did the rental sale/exclusion answers ... It is still only giving me part of the 121 exclusion. I think you have the only way to make this turkey dance.

Cheers

[Carl]

I've never had to deal with the program personally for a situation where the extension applied. But I can imagine. There's other parts, particularly in the rental section, where the program doesn't provide the necessary clarity that I think it should. So that lack of clarity seems to consistently lead to wrong answers and wrong selections.

However, that doesn't totally fall on TurboTax. Some of the wrong answers/selections I see would be correct, if the user would just *read* *the* *small* *print* that's typically directly under the box or checkbox they put the wrong data or made the wrong selection in.

[Carl]

Well, I tried doing a scenario mock-up using your dates. It works perfectly. When you get a screen that asks "did you use this home for anything other than your primary home?" then:

-If the last occupant of the property prior to the closing date of the sale was a tenant, select NO. Then for reason, select "other reasons". Then select "military...".

Then the screen after that will ask you if you lived in home "2 of last <whatever>"

When I select yes, the entire amount is excluded from taxation.