Accumulated Depreciation on Primary Home Sale

[klrgn]

I'm getting stuck on accumulated depreciation and adjusting our cost basis after selling a primary home, where part was rented out, last year. Here is an example scenario similar to mine (for a single filer):

Initial Purchase Price 5 years ago: $250K 

Accumulated Depreciation from renting out a room in the house: $20K

Home Sale: $600K

Adjusted Cost Basis (excluding other times): $230K (Original price minus accumulated depreciation)

Initial Gain on Sale: $370K

Gain on Sale (minus primary home exemption of $250K): $120K (taxed as capital gains)

Depreciation Recapture: $20K (taxed as ordinary income)

In the above...it seems like depreciation is taxed twice because it both increases the capital gain and is recaptured. Is the above the correct way to treat it in this scenario or should we not be adjusting the cost basis? 

[DianeW777]

It depends on whether you still have the room asset on your tax return for the rental activity, It should not be duplicated so try using the information below to report it once.

1. If it is listed as an asset on your return for 2024, carried from 2023, then simply indicate it was converted to personal use 100%. Do not enter sales details in the rental asset.
2. Enter your sale as a sale of home. Enter the depreciation expense you have claimed on the room rental for all years when asked.
   1. TurboTax will calculate the depreciation recapture and the amount allowed for home sale exclusion if you qualify.

If you qualify for the home sale exclusion follow the steps below.

• Where do I enter my Form 1099-S?

The rules of capital gain exclusion for the sale of your main home must occur within five years in your situation. It's necessary to show the time that it was your main home.  Below is a summary of the requirements for exclusion of gain on your main home sale.

Exclusion amount: If you meet certain conditions, you may exclude the first $250,000 of gain from the sale of your home from your income and avoid paying taxes on it. The exclusion is increased to $500,000 for a married couple filing jointly.

Key Eligibility Requirements: IRS Publication 523

1. Ownership: If you owned the home for at least 24 months (2 years) out of the last 5 years leading up to the date of sale (date of the closing), you meet the ownership requirement. For a married couple filing jointly, only one spouse has to meet the ownership requirement.
2. Use: If you owned the home and used it as your residence for at least 24 months of the previous 5 years, you meet the residence requirement. The 24 months of residence can fall anywhere within the 5-year period, and it doesn't have to be a single block of time. All that is required is a total of 24 months (730 days) of residence during the 5-year period. Unlike the ownership requirement, each spouse must meet the residence requirement individually for a married couple filing jointly to get the full exclusion.
3. Look Back Period: If you didn't sell another home during the 2-year period before the date of sale (or, if you did sell another home during this period, but didn't take an exclusion of the gain earned from it), you meet the look-back requirement. You may take the exclusion only once during a 2-year period.
4. Exceptions - May not apply to you and can be reviewed at the link above.

[klrgn]

I'm still confused. I'm mostly focused on two parts as part of entering the home sale (after showing it converting to personal use)...1) adjusting the cost basis for my primary home sale and 2) accumulated depreciation recapture. If the cost basis is adjusted then it increases the gain (which in our case is beyond the threshold for capital gains exclusion) so that adds to the taxable gains. In addition, Turbo Tax has us report the accumulated depreciation for deprecation recapture (which is also taxed as a separate item from what I can tell). 

I recognize we're benefitting from the home sale exclusion, but it seems the depreciation portion is taxed twice by reducing the cost base (thereby increasing the gain) and also being recaptured. Is it right that it would be handled that way?

[DianeW777 · Accepted solution]

This does require creativity when only a room is rented. After you indicate it was converted to personal use, do not adjust your cost basis for the sale of your home, use the full cost basis. Simply enter the full cost basis, and when asked enter the total of depreciation expense used on prior returns and, if applicable the current year.

When you enter the home sale in TurboTax it will ask for a couple of items that are needed to report the sale correctly.  

1. The total depreciation expense that was allowed during the period it was available for rent.  Check your prior tax returns for this figure.
2. The number of days the property was available for rent during the ownership period 
   1. Since the whole house wasn't rented you should further use the square feet of the space rented and divide it by the total square feet of your home. Multiply that result by the number of days rented. This is the number of days to enter to appropriately reflect the correct gain attributable to the rental portion of the house.

Results:

1. The amount of depreciation that was allowed will be completely taxable up to the amount of gain received on the sale.
2. The remaining gain if any, will be split between taxable and amount eligible for exclusion by using the following formula.
   • The total days available for rent (indicated above) will be divided by the total days owned to determine the portion of the remaining amount of gain that is taxable for the rental period
   • The balance will be eligible for the home sale exclusion
3. TurboTax will do all the calculations based on your entry

Please update here is you have more questions and we will help.

@klrgn