Sale of Rental Property - convert to personal use?

[joecocuzzo]

I owned an inherited house jointly with my sister (50/50) and we rented it out mainly weekly in the summer but sometimes off season monthly.   She used it max 2 weeks per year, I did not use it.

In 2022 she bought me out and she will not be renting it any further, but using it as her retirement home.   So when she does her Turbo Tax return (with Premier) she will answer converted to personal use = Y.     I have been bought out, so I guess I can say converted to personal use = N ?    Not sure if I am answering for my 50% or not.   Also not sure what the Y/N answer does to my return.   

Separately I know I will have capital gain because I have a basis in my half of the house which is 50% of value when I inherited, and the buy out was based on 50% of professional appraisal.

[GeorgeM777]

Yes, on the screen, Tell Us More About This Rental Asset, there is a box to check indicating that the rental property was "sold, retired, stolen, destroyed, disposed of, converted to personal use, traded in, or given away (or it's no longer being used in this business for some other reason)."  That is the box that you and your sister will check-off.  On the same screen, your sister and you will also have to indicate the date you "..sold/retired [the rental property] from use."

Regarding your interest in the rental property, it appears you will have a capital gain.  Additionally, because this was a rental property, did you take depreciation on the asset?  You should have taken depreciation, and therefore, you may have to recapture some of that depreciation when you enter your basis and sales proceeds.  Depreciation recapture is some percentage amount of depreciation taken in prior years that will be taxed, hence "recaptured," because the property now has been taken out of rental service.  If you used TurboTax during the years the property was a rental property, TurboTax will show you the depreciation taken to date on the screen, Confirm Your Prior Depreciation.  

Because it appears your rental property was not always rented and incurred personal use, be mindful of the limitations that may cause a part-time rental to become a personal residence.  You are correct that 14 days is part of that analysis.  The IRS considers the rental property to be a personal residence based on the following: 

If you rent a dwelling unit to others that you also use as a residence, limitations may apply to the rental expenses you can deduct. You're considered to use a dwelling unit as a residence if you use it for personal purposes during the tax year for a number of days that’s more than the greater of:

1. 14 days, or
2. 10% of the total days you rent it to others at a fair rental price.

The IRS also includes the following example of a vacation home that might be a personal residence and thus not a rental property.

It's possible that you'll use more than one dwelling unit as a residence during the year. For example, if you live in your main home for 11 months, your home is a dwelling unit used as a residence. If you live in your vacation home for the other 30 days of the year, your vacation home is also a dwelling unit used as a residence unless you rent your vacation home to others at a fair rental value for 300 or more days during the year in this example.

[Carl]

you have no need to convert anything to personal use on your tax return. Simply report the sale in the SCH E section of the program. Here's the general guidance.

Reporting the Sale of Rental Property

If you qualify for the "lived in 2 of last 5 years" capital gains exclusion, then when prompted you WILL indicate that this sale DOES INCLUDE the sale of your main home. For AD MIL personnel who don't qualify because of PCS orders, select this option anyway, because you "MIGHT" qualify for at last a partial exclusion.

Start working through Rental & Royalty Income (SCH E) "AS IF" you did not sell the property. One of the screens near the start will have a selection on it for "I sold or otherwise disposed of this property in  2021". Select it. After you select the "I sold or otherwise disposed of this property in 2021" you continue working it through "as if" you still own it. When you come to the summary screen you will enter all of your rental income and expenses, even if it's zero. Then you MUST work through the "Sale of Property/Depreciation" section. You must work through each individual asset one at a time to report its disposition (in your case, all your rental assets were sold).

Understand that if more than the property itself is listed in your assets list, then you need to allocate your sales price across all of your assets.  You will only allocate the structure sales price; you will NOT allocate the land sales price, since the land is not a depreciable asset.  Then if you sold this rental at a gain, you must show a gain on all assets, even if that gain is $1 on some assets. Likewise, if you sold at a loss then you must show a loss on all assets, even if that loss is $1 on some assets.

Basically, when working through an asset you select the option for "I stopped using this asset in 2021" and go from there. Note that you MUST do this for EACH AND EVERY asset listed.

When you finish working through everything listed in the assets section, if you ever at any time you owned this rental you claimed vehicle expenses, then you must also work through the vehicle section and show the disposition of the vehicle. Most likely, your vehicle disposition will be "removed for personal use", as I seriously doubt you sold your vehicle as a part of this rental sale.

[joecocuzzo]

We did take depreciation, so I know I have recapture.    Direct expenses exceeded rental income (not uncommon for the area) so I think the capital loss with cancel out the recapture on the LTCG on the buy out.

I am just puzzled about "convert to personal use" as my sister did convert to HER personal use, but I was bought out so I am not using property for personal use.   Not sure if that has any tax effect for me and how I should answer.

And I know about the 14 day rule.  My sister lived far away from the house, and only took a short vacation at the property each year.  The rest of the year the house was weekly summer rental, sometimes off season rental, or empty.

[Carl]

What your sister does with the property after she owns it, is irrelevant. "YOU" have no need to convert anything to personal use because "YOU" have no personal use of the property by "ANYBODY" during the period of time "YOU" had ownership in it, at any percentage. Simply report the sale and be done with it.

Using the guidance above, the program (not you) will take care of depreciation recapture, as well as any PAL carry over losses if there are any.

When done, you can review the SCH D and the 4797 for the details of the sale transaction.

[joecocuzzo]

Makes sense, thanks.