Allocation of capital gain on sale of dwelling with an ADU?

[Soane]

I'm confused about tax treatment when selling a house with an ADU that's been rented for years.  Suppose I bought my 1,800 square foot primary residence for $125,000 in 2008.   Today, it has a market value of $300,000.   In 2023 I construct a 600 square foot accessory dwelling unit for $125,000.   

Let's say that I sell this property down the road for $550,000, after having depreciated the ADU by $25,000 to a basis of $100,000.

Ignoring land value for a moment, how would I allocate the gain on the sale between the house and ADU?  Does it get allocated 50% to each unit, since I paid $125,000 for each of them?  Or maybe 25% to the ADU since it constitutes 1/4 of the total square footage?   Or, even,  $125k/$300k reflecting the percentage of value at the time I build the ADU?  Or...heaven forbid...some other method...

I do understand that the depreciation I claim will come back on sale at my ordinary income rate (up to 25%), and I assume this gets subtracted from the ADU"s share of capital gains.

Can someone make sense of this?

[tagteam]

See https://ttlc.intuit.com/community/taxes/discussion/selling-property-with-adu-do-i-need-to-pay-deprec...

I'll also page @AmeliesUncle 

[Opus 17]

Assuming you sell the property as a single lot and are not splitting the property, then:

Remember that "real property" is land, plus anything that is permanently attached.  You bought the land and you plan to sell the land (along with structures, trees, shrubs, utility services, and anything else that happens to be attached to the land.  You don't allocate costs between the different structures on the land unless you are dividing the land into multiple lots and selling them separately.  All your adjustments to basis (increases for improvements and decreases for business use) happen to the land.  

Your cost basis is the original cost ($125,000) plus the cost of improvements ($125,000) minus depreciation.

If you want to divide the land into separate lots and sell the ADU on its own lot without selling the main home, that will indeed be more complicated and may require professional review.  

[AmeliesUncle · Accepted solution]

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@Soane wrote:

Or, even,  $125k/$300k reflecting the percentage of value at the time I build the ADU? 

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You allocate the selling price based on the Fair Market Value of each building at the time of sale.  So you would want to get appraisal that would value both building separately (in some areas, your county real estate tax assessment might already do that).

For example, let's say that selling price is $400,000 (ignoring land, for simplicity) and perhaps the value of your main home at that time is $250,000 and the value of the ADU is $150,000.  You would use $250,000 for the sale price of you main home, and $150,000 for the sale price of the ADU.   

[Soane]

That makes complete sense!  Thank you, AmeliesUncle!