Depreciation recapture on rented bedroom

[taxtimecody]

Hi,

I'm stuck trying to work out a depreciation recapture issue that's affecting my tax planning. I sold my house this year at a gain below the gain exclusion limit. Before the sell, I rented out a spare bedroom & depreciated it each year. From my reading of Pub. 523 & completion of the worksheets, I land at:

"Your entire gain is excludible from your income and you have no gain to report on your tax return. The Reporting Your Home Sale' section does not apply to you." Problem is I know I'm going to get a 1099-S since I had used the property for rental and therefore will have to report the home sale. Since I don't seem to fit cleanly into the p523 flows (all gain excludible but still having to report the sale), I'm trying to understand if I'll be subject to depreciation recapture. Or to put it another way, is depreciation recapture mandatory on a house sale with gain less than the gain exclusion maximum?

Thanks!

Cody

[tagteam]

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@taxtimecody wrote:

....I'm trying to understand if I'll be subject to depreciation recapture.

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In fact you will, at up to 25% (depending upon your income) of the depreciation allowed or allowable.

See https://www.irs.gov/faqs/capital-gains-losses-and-sale-of-home/property-basis-sale-of-home-etc/prope...

[Hal_Al]

Yes,  depreciation recapture  is mandatory on a house sale with gain less than the gain exclusion maximum.

In TurboTax (TT), the home sale interview will ask if you ever claimed depreciation.  When you answer yes and fill in the amount, TT will show the recapture as a section 1250  capital gain on Schedule D

[taxtimecody]

Thanks for the response, @tagteam! I figured as much- it would be great if p523's Worksheet 3 could be updated to better reflect that since it states someone in my position has no gain to report.

[taxtimecody]

Thanks @Hal_Al! Can you please point me to a source for that? I'd just like to know for my own understanding.

From my reading of the Form 8949 Instructions and Publication 523 I should be able to just declare 0 gain using the gain exclusion on Form 8949 (Worksheet 3 of p523 concludes my entire gain is excludible). With 0 gain on Form 8949 copied to Schedule D, I'd bypass the Schedule D depreciation recapture question and call it a day.

[tagteam]

@taxtimecody There is information, which is almost exact, in the link I posted.

For rental property, the law has additional limits on the amount you may exclude. You may not exclude the part of your gain equal to any depreciation deduction allowed or allowable for periods after May 6, 1997.

Generally, the law allows an annual depreciation deduction on your rental property and you must reduce the basis of the property by the amount of your depreciation deductions. If you don't claim some or all of the depreciation deductions allowable under the law, you must still reduce the basis of the property by the amount allowable before determining your gain on the sale of the property.  

The gain attributable to the depreciation may be subject to the 25% unrecaptured Section 1250 gain tax rate. Additionally, taxable gain on the sale may be subject to a 3.8% Net Investment Income Tax. 

[taxtimecody]

Hi @tagteam, 

My issue is that this was a sale of my main home that had a rented bedroom, not a rental property to be sure. The link you provided explicitly pertains to rental property and I'm not confident my situation fits it. Publication 523 even calls out exceptions for business or rental use that don't affect gain/loss calculations:

"If the space you used for business of rental purposes was within the living area of the home, then your usage doesn't affect your gain or loss calculations. Examples of spaces within the living area include a rented spare bedroom and attic space used as a home office. In contrast, business or rental spaces not within the living area affect your gain/loss calculations. Examples of space not within the living area include a first-floor storefront with an attached residence; a rented apartment in a duplex; or a working farm with a farmhouse on the property."

From my perspective, one could make the case that since the conclusion reached by Publication 523 states "your entire gain is excludible from your income and you have no gain to report on your tax return," one could report 0 gain on the sale and there would therefore be no recapturable depreciation.

[tagteam]

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@taxtimecody wrote:

From my perspective, one could make the case............

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One could, but then one could get audited and the IRS will whip out Sections 1250 and 121(d)(6) of the Internal Revenue Code. The end result of the foregoing will not favor your perspective.

[Hal_Al]

If you actually claimed depreciation, on your tax returns, in the past, then you MUST claim recapture when you sell it.

If you did not claim recapture, then I agree,  the activity (renting a room in your home) does not  require recapture of the depreciation your "shoulda took", as it would for a true rental property.

[tagteam]

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@Hal_Al wrote:

If you actually claimed depreciation, on your tax returns, in the past, then you MUST claim recapture when you sell it.

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That was mentioned in the original post: "I rented out a spare bedroom & depreciated it each year."

After actually claiming deductions for depreciation on a previous return (or returns), it would be hard to fathom that the IRS would knowingly forego recapture when the property is sold.

[pk]

Also note that the accumulated depreciation allowable or claimed reduces your basis in the property and therefore increases  your gain.  Thus as @Hal_Al  and @tagteam  has pointed you do have to include the  allowable / taken  depreciation as ordinary gain before the exclusion is applied.  

[taxtimecody]

I'm sure y'all are correct. I didn't know whether the gain exclusion or depreciation would take precedence but now I must assume that depreciation must win out from the gist I get reading 121(d)(6) (even if the code's legalese is a bit much for a layperson like me to follow). I maintain my situation was not accounted for in Publication 523 which is a shame but no matter (perhaps I'll leave a comment). Anyway, it was great to get such a second (and third) opinion on the matter so thank you both very much. I will plan for the depreciation recapture this year accordingly (yippee... ).

Thanks again,

Cody