Recapture Depreciation on Duplex & Appliances, Bedroom rented inside "Home" portion, Deceased Spouse's Recapture

[decogeek]

     I was reading IRS publication 523 to figure out how to account for my duplex sale. I've owned the property for 30 years, so you know how these things can get complicated...

     First of all, the second floor was rented as it's own apartment and it is 35.5% of the whole house. I rented the basement bedroom, which has gone through several refrigerators in 30 years. The upstairs apartment also has had several full sets of appliances in 30 years.

     From reading publication 523, it looks like I need to recapture the 35.5% depreciation on the second floor, but not the rest from the basement rental, because that is considered a spare bedroom in my "home" portion of the house. According to their worksheet, the basement portion of the depreciation gets figured into the gain on my home portion to determine whether I go over the $500,000 limit for a married couple that would make that portion of my gain taxable.

     1. The first question is am I right that I don't have to recapture the "home" portion of the depreciation?

     2. The second question is... Do I recapture the gain on appliance depreciation?

     3. How do I account for depreciated appliances that are gone, versus depreciated appliances that were sold with the house in the home or second floor apartment?  (Let's say they had a value of $900 for the second floor and they were 100% depreciated. The basement fridge  and washer / dryer were all but $150 depreciated and were worth $850 all together. Some appliances were listed as 179 depreciation back in 1996-1999.)

     My first husband died in Sept. 2009, So I stepped up the value of his half of the property and am still depreciating his half of the house. I am not planning to recapture his half of the depreciation from 1990 to Sept. 2009.  (I am not in a community property state.)

     4. Am I right that I just ignore his portion of the depreciation taken up to Sept. 2009?

I hope you can answer some of these, because it is hard to find answers beyond the basic stuff.

[DianeW777]

Yes, we can help with the answers to your questions. The questions will be answered based on your order above.

1. You do not have to recapture the home portion.  There was never any depreciation allowance on the entire section of your home that was used as your personal residence.  This does not include any portion where depreciation has been used as an expense for renting out either the basement or the second floor. You must account for the basement bedroom percentage as well just like the upstairs apartment.
2. Appliances.  Any appliance that was junked because it was no longer functional and had to be replaced, would not have a sales price attached to it.  Those appliances would not have depreciation recapture because there was nothing to sell.  If you allocate a portion of the sales price to any appliances that are still functional and active then a small portion of any depreciation for the current appliance(s) would taxable as ordinary income.
   • Sales price and sales expense allocation:  Use the original cost of each asset listed on depreciation, add those together then divide each one by the combined total to find the percentage of the cost for each asset.  Use that percentage times the sales price and sales expenses to find the selling price/sales expenses for each asset.

     Example:  Original Cost (of each asset on your depreciation schedule, include active appliances to your list)

     $10,000 Land                = 13.33% 

     $50,000 House              = 66.67%

     $15,000 Improvements  = 20%

     $75,000 Total                 = 100%

     4. If you filed jointly with your first husband, you must recapture any depreciation used on the tax return during the early years of rental (1990 - 9/2009).  Then, you would add this to the remainder of the depreciation expense that you used from the date of death forward on the stepped-up portion of the house for the half you inherited.

[AmeliesUncle · Accepted solution]

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@decogeek wrote:

     1. The first question is am I right that I don't have to recapture the "home" portion of the depreciation?

     2. The second question is... Do I recapture the gain on appliance depreciation?

     3. How do I account for depreciated appliances that are gone, versus depreciated appliances that were sold with the house in the home or second floor apartment?  (Let's say they had a value of $900 for the second floor and they were 100% depreciated. The basement fridge  and washer / dryer were all but $150 depreciated and were worth $850 all together. Some appliances were listed as 179 depreciation back in 1996-1999.)

     My first husband died in Sept. 2009, So I stepped up the value of his half of the property and am still depreciating his half of the house. I am not planning to recapture his half of the depreciation from 1990 to Sept. 2009.  (I am not in a community property state.)

     4. Am I right that I just ignore his portion of the depreciation taken up to Sept. 2009?

1)  You will still pay tax on the depreciation that was taken on your 'home'.   The gain from that rental room is is covered by your $250,000 exclusion, but that exclusion will not get rid of the depreciation.  The full rental apartment can not be covered by the $250,000 exclusion.

2)  Sort of, yes.  You should enter the sale price as the Fair Market Value of the appliances.  If that Fair Market Value (selling price) is higher than the Basis, that 'gain' is recaptured depreciation.  If the FMV/selling price is less than the Basis, you get to claim a loss.  The program should do that automatically.

3a)  The old appliances that you no longer have can be deleted. 

3b) Unless your sales agreement sets out a price for "personal property", you should adjust the sales price of the house.  For example, let's say you sold everything for $200,000, and let's say you had decided to enter the FMV/selling price of all of the appliances for $1500.  You would allocate the $1500 among the appliances, and enter the house selling price of $198,500.

4)  Yes.  Any of 'his' depreciation prior to his death disappeared the day he died (that is part of the step-up in Basis).  You only need to account for ALL of 'your' depreciation and only 'his' depreciation after his death.

[decogeek]

@DianeW777  ,

     More about the basement bedroom rental: I was told by a city housing inspector that the only reason it was legal for me to rent the basement bedroom is that it was considered as a spare bedroom in my home. This was important because my house was not zoned as a triplex. The neighbors complained that I had a renter in the basement and she came over and looked at it and proclaimed it a spare bedroom within my space. She made us put a door in the back hallway to shut off the tenants from the basement, although she said they could still come down to use the laundry room.

     Later, the basement bedroom was used by my husband as a home office, where we didn't depreciate anymore and just took the simplified home office deduction.

     Here is how the basement spare bedroom space was used for the final 5 years prior to the sale:

21.5 months (from 8/18/15 to 5/1/17) as a rental to our adult son (depreciation taken)

18 months (from 5/1/17 to 12/8/18) used as our home office while we lived in the house (not depreciated)

20.5 months (from 12/8/18 to 8/18/20) empty while the house was being remodeled for the sale. The basement sewer backed up and much work had to be redone during that time. Our primary residence and office moved to another house for the final 20.5 months when the basement was empty.

     Does this change the answer to question #1?

[decogeek]

@AmeliesUncle  ,

Thanks for helping me with my situation. I am hoping to make sure I understand about question #4. I am planning to recapture my half of the depreciation between 1990 and Sept 2009. The other half which belongs to my late husband, just goes away and doesn't have to be reported to the IRS or anything, correct?

From Sept 2009 until the sale date, I will recapture 100% of the depreciation. Is that what you meant?

Also, can you look at the additional information I sent to Diane about the basement and see if that changes the answer to question #1 at all? I really appreciate you trying to clarify for me. There are a lot of confusing issues!

[AmeliesUncle]

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@decogeek wrote:

@AmeliesUncle  ,

 I am planning to recapture my half of the depreciation between 1990 and Sept 2009. The other half which belongs to my late husband, just goes away and doesn't have to be reported to the IRS or anything, correct?

From Sept 2009 until the sale date, I will recapture 100% of the depreciation. Is that what you meant?

Also, can you look at the additional information I sent to Diane about the basement and see if that changes the answer to question #1 at all? I really appreciate you trying to clarify for me. There are a lot of confusing issues!

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Correct.

Any depreciation that was taken or that you were eligible to take (not including your husband's portion before he died), will be subject to tax if it is sold at a gain.  No other details matter about that.

[decogeek]

Is there anywhere on the 4797 form that I have to account for the old section 179 depreciation taken on appliances? (no longer in service)

Does the IRS add up all the different types of depreciation taken over 30 years? Do they expect the numbers to add up to your recapture when you sell? What if the numbers don't add up due to appliances taken out of service, or stepped-up basis, or whatever else? 

[Carl]

1. The first question is am I right that I don't have to recapture the "home" portion of the depreciation?

That portion of your home that was not ever rented out or used for any other business purpose, was never depreciated. Therefore, there is no "home" portion of depreciation to be recaptured.

2. The second question is... Do I recapture the gain on appliance depreciation?

If you sold the appliance, then yes. However, if you're talking about an old appliance you no longer have, that appliance shouldn't even be listed in your Assets/Depreciation section of your 2020 tax return *IF* and only if you took that appliance out of service "before" Jan 1, 2020.
To correctly take an asset out of service and junking it, without having to sell it or recapture the depreciation, work through that asset. Select YES on the screen for "I stopped using this asset in 2020". Then on the "Special Handling Required?" screen, select YES also. If you select NO on that screen, you are "forced" to enter sales information. So if you did not sell that appliance asset, select YES for speical handling required. That's all you need to do with that asset.

3. How do I account for depreciated appliances that are gone,

Just do exactly as I stated in my response to #2 above.

versus depreciated appliances that were sold with the house in the home or second floor apartment?

when working through those appliances in the assets/depreciation section, you will select NO on the "Special Handling Required?" screen. Then you'll enter your sales information for that appliance. The program will then take care of the depreciation recapture "for you".

  Some appliances were listed as 179 depreciation back in 1996-1999.)

If the appliance as since been junked, my response to #2 above applies. Otherwise, select NO on the "Special Handling Required?" screen, enter your sales information, and the program takes care of depreciation recapture "for you".

My first husband died in Sept. 2009, So I stepped up the value of his half of the property and am still depreciating his half of the house. I am not planning to recapture his half of the depreciation from 1990 to Sept. 2009. (I am not in a community property state.)

4. Am I right that I just ignore his portion of the depreciation taken up to Sept. 2009?

You are correct. Your "step up" in basis in the year of his passing basically "cancelled out" his share of the depreciation. However, you "should" have been depreciating the stepped out amount, with depreciation starting on the date of his passing - which is the date you "stepped up" the basis. That depreciation "does" have to be recaptured.

[decogeek]

@DianeW777 @AmeliesUncle @Carl 

This is the worksheet I am looking at from pg. 15 of IRS Pub. 523 (2020). The worksheet is in here to help figure the gain on the "Home" part of the house (as opposed to the "Business" part of the house.) There are lines to write in depreciation taken from a home office or renting out a spare bedroom in your home. This is the "Home" portion of the depreciation I am referring to in my question #1. I'm still confused by how this worksheet makes sense with the answers I've gotten. Can you help me understand what is going on here?

[AmeliesUncle]

Re-read my answers.  They still apply.  As I said before, if it is sold at a gain you will end up paying tax on ALL of the depreciation that you were eligible to take.