Sale of Rental Property that was originally my Primary Residence

[AB-Tax]

I am using Turbo Tax Premier on Desktop (Windows). I need help in reporting the sale of rental property in 2022. Here are the details:

- Bought a townhouse (property 1) as primary property in Oct, 2007 for $256, 500.
- Lived in the property (primary residence) through March, 2015. Bought a new primary residence in 2015, and  put the previous house (property 1) for rent in 2015. FMV at the time of rental conversion was $235, 000. The Asset and Land percentages were entered as per the township tax record, about 75/25.
- Rented property 1 from 2015 to Oct, 30, 2022.
- Sold the rental property (property 1) on Nov 30, 2022 for $350, 000. So, for 1 month (Nov, 2022), the property did not have any tenant when I was fixing inspection items. The property was already under contract prior to the tenants moving out.
- Closing costs for sale were $18,000 and additional required repairs were $1,600
- In March, 2022, I updated the Furnace, AC for $9820, and other appliance for $600. 
- I have few assets that is being depreciated, such as carpet, and a new concrete patio.
- Property 1 depreciation is around 49K (including 2022)
- When property 1 was for personal use, I had updated my Kitchen, windows, doors, for around 14K. I did not enter this in the asset section, since I assumed the upgrades to be part of the FMV at the time of the rental. So, no depreciation was taken on these capital improvements.

- My expense (recording, title, attorney, etc.) during original purchase in 2007 was refinance was around 3.2K. I am not sure if this can be used, but just mentioning it here.

My cost basis when placing the property for rental use in 2015 was lower than the purchase price. I need help in TurboTax to report this sale of rental property correctly, so that I don't overpay my taxes. Looking at similar questions on this community forums, I see some people recommending reporting the sale in the rental section using the asset and sale of property/depreciation section OR using the Sale of Business Property section. I have tried both options, and get different results. 

Could someone tell the correct way to enter the sale information. I'd highly appreciate if someone walks me through the steps to show this sale of rental property - where would I enter the cost basis, and what needs to be included in the cost basis, sales expense, etc. 

[PatriciaV]

Considering the complexity of this transaction and the short time left before the filing deadline, you may wish to consider upgrading to TurboTax Live. This online service provides step-by-step guidance from a tax expert whenever you need assistance. You can even talk to a tax expert live while you both look at your return.

[AB-Tax]

Thanks @PatriciaV. I have had better experience in getting the right answers from experts in this forum. Similar questions have been answered before, and there are two different approaches - entering the sale in the rental section vs sale of business property. I am hoping someone is able to provide me the steps. I have tried both options and there is a difference of around 3.2k in taxes (Entering the details in Sale of Business Property yields better results). I don't want to overpay by entering the details in the wrong section. Can someone in this forum help!

[DianeW777]

Assistance here should help you complete your sale in TurboTax. The answers to your questions follow....

1. My cost basis when placing the property for rental use in 2015 was lower than the purchase price - in your situation you must add the difference between your cost and the market value used for depreciation to your sales expenses so that the actual cost is counted for your sale because it is not part of your actual cost for asset depreciation.  Add all expenses for capital improvements and your original cost of the property to arrive at the difference between value used for depreciation and actual cost. 
   • In the selling expense field use this plus all of the sales expense paid.
2. See the information below to walk you through the entry of your sale.

The IRS requires that the selling price be proportionately prorated to arrive at a selling price for each 'piece' of a rental property since many assets can be placed in service at different times, such as your roof.

The selling price should be prorated for each asset then entered for each asset when you indicate they were sold or disposed of. You will not lose the remaining depreciation because you will use the remaining basis against the selling price to determine gain or loss. 

To figure out the selling price for each asset:

1. Take the current basis of each asset against the total combined basis of all of your assets to figure out the sales price for each one; OR 
2. Determine a fair market value for each asset against the total value of all assets to figure out the sale price for each one. 

Use the original cost of each asset listed on depreciation (all belongs to house B now) 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)

$10,000 Land                = 13.33% 

$50,000 House              = 66.67%

$15,000 Improvements  = 20%

$75,000 Total                 = 100%

Multiply each percentage times the sales price/sales expenses to arrive at each individual sales price/sales expense.

I hope this example provides clarification to enter your sale.

You need to dispose of the property by telling TurboTax how and when it was disposed of.  Follow the instructions below.

1. Click on Income & Expenses
2. Under Your income and expenses, scroll down to
3. Rental properties and royalties, click Edit/Add
4. Do you want to review your rental?, click Yes
5. Under Rent and Royalty Summary, click Edit
6. Click Update to the right of Assets/Depreciation.
7. Do you want to go directly to your asset summary?, click Yes and Continue
8. Click Edit to the right of each asset to be disposed
9. Go through several screens until you get to Tell Us More About This Rental Asset
10. Click on This item was sold…….   And continue to answer the questions

You might also review information here.

[robertw65]

It sounds like you are not in the real estate business.  Assuming this is true, your rental property is a rental and is not business property.  The improvements made before the property became a rental should be added to your basis.  The closing costs for the original purchase and refinance should be added to your basis.  Also, make sure you add any rental losses over the years, if any, to the calculation of the gain on the sale of your rental property.

[AB-Tax]

@DianeW777 , thanks for the explanation.  Can I not enter the sale date for each asset, then check 'Yes' in the Special Handling section and use the Sale of Business Property section to enter all the information? I understand that I will need to add the depreciation for all assets if I used this approach. This seems a lot cleaner (and somewhat easier) for me to enter. But I want to make sure that this process is correct.

The only difference I see is that the land portion does not show up separately in Form 4797 when I enter it in the 'Sale of Business Property' section (I am assuming that the tax will be same once I enter the difference between Rental FMV and actual purchase cost)

Another clarification - For 1 month (Nov 2022) that I did not have a renter, the house of under contract and I was fixing inspection items. Can I deduct the 1 month mortgage interest, property tax, water bill and condo association fee as sales expense?  The above expenses incurred from Jan - Oct when I had a renter was captured under Rental expense. I left out 1month of expenses, because I did not have a renter and the house was not available for renting.

[AB-Tax]

@robertw65 , TT automatically transfers the numbers to the Sale of Business Property section and generates Form 4797, even if you enter the sale info in the Rental expense. Within TT there are 2 sections where you can enter the rental sale details, and these are entered somewhat differently. But it ends up in the same place. I somehow find entering the details in the Sale of Business Property section easier.

Also, you cannot (and should not) update the cost basis in the rental section. It will screw up your depreciation. There are many threads on that topic. Hence @DianeW777 has propsed the approach to add the difference between rental basis and actual cost as sales expense. I am yet to try it out.

You have mentioned adding the original closing and refinance cost to the basis. I wasn't aware I could do that. These are recording, title, attorney, etc.?

[DianeW777]

Yes, you can use that approach if you choose. Yes, the overall gain will be the same, however the land had no depreciation so you could enter that as a separate sale.

No you cannot use mortgage interest, property taxes, or utilities or the condo fees as a sales expense. If the property was not available it would be expenses to maintain the property for sale. However, you could take that one month of real estate tax as an itemized deduction because it is not a requirement for the property tax be for your home. 

@AB-Tax 

[DianeW777]

Yes, you would add the purchase or original expenses to purchase your rental to your original basis also. This would be part of the formula provided earlier. 

• Add all expenses for capital improvements and your original cost of the property (should include purchase expenses from your original closing statement) to arrive at the difference between value used for depreciation and actual cost. 
• In the selling expense field use this plus all of the sales expense paid.

@AB-Tax 

[AB-Tax]

@DianeW777 , just to be clear, do I HAVE to create a separate sale for land? Or is it something that I can if I want to? Is there any reason I would want to create a separate sale for the land?

[DianeW777]

Yes.  The land is not subject to the rule for Section 1250 property while the building itself, is. TurboTax knows the difference when entered correctly.

• Section 1250 gain is subject to a maximum 25% capital gain tax rate for depreciable real property held more than one year (rental building/home).
• Land is subject to capital gain tax rates at a maximum of 20% because it is not depreciable property.

These rates come into play if your overall income is in a tax bracket higher than the rates mentioned.

@AB-Tax 

[AB-Tax]

@DianeW777 , I am almost done. Thanks for your help so far. Just a couple of follow up questions. I installed a new HVAC & changed an appliance on 03/01/2022. I entered the HVAC and the appliance as Assets, but TT did not calculate any depreciation. Most likely because I disposed them within the year - I rented the property through 10/31/2022 and sold the property on 11/30/2022.

Questions:

- Am I correct in entering the HVAC and the appliance in the asset section of the rental, and prorating my gain  and expenses across these assets as well? Or should I just enter them as a sales expense? By allocating my expenses across these assets, I am basically increasing the cost price. Is that correct?

- I added the difference between Purchase Cost and Rental Basis (256.5 - 235 = 21.5K)  to the other Sales Expenses. Basically, I increased the sales expense by 21.5K. I hope this is what you meant.

- I am responding "No" to the question- "Was this asset included in the sale of your main home". Is that accurate?

- I prorated the sales price and the expenses as per the table below.  By calculating the percentages based on the cost basis in TT and factoring ALL assets, I have effectively changed the percentage of Asset and Land of the Rental Unit. It no longer matches the township records. Is this what you proposed? Can you please confirm if my calculations make sense. I just want to make sure I understood your formula.

Asset	Cost Basis from TT	Cost Basis %	Sales Price based on TT %	Expense allocation based on TT %
Rental - Home	$                                119,616	62.83%	$                                                        219,883	$                                                                                     36,713
Rental - Land	$                                   57,692	30.30%	$                                                        106,051	$                                                                                     17,707
Other Asset 1	$                                      1,200	0.63%	$                                                              2,206	$                                                                                            368
Other Asset 1	$                                      1,492	0.78%	$                                                              2,743	$                                                                                            458
HVAC	$                                      9,820	5.16%	$                                                           18,051	$                                                                                        3,014
Appliance 1	$                                           580	0.30%	$                                                              1,066	$                                                                                            178
TOTAL	$                                190,400	100.00%	$                                                        350,000	$                                                                                     58,438

[DianeW777]

Here are your answers and you are all set to complete your tax return.

1. Am I correct in entering the HVAC and the appliance in the asset section of the rental, and prorating my gain  and expenses across these assets as well? Or should I just enter them as a sales expense? By allocating my expenses across these assets, I am basically increasing the cost price. Is that correct?
   1. No, an asset placed in service and removed from service in the same year are not allowed to be depreciated.  Add them to the original cost basis and keep the entire sales price for the combined assets in one entry.
2. I added the difference between Purchase Cost and Rental Basis (256.5 - 235 = 21.5K)  to the other Sales Expenses. Basically, I increased the sales expense by 21.5K. I hope this is what you meant.
   1. Yes, that is what I meant.  You will also add the amount from step 1 here as well.
3. Can you please confirm if my calculations make sense. I just want to make sure I understood your formula.
   1. Yes, spot checking a few calculations this all seem accurate.  Keep all of your records with your tax return.

[AB-Tax]

@DianeW777 , I think I am more or less done with my return. Thanks for your ongoing help.

I just want to clarify a few things.

- I removed the HVAC and the appliance from Asset section. TT was not calculating any depreciation, but I anyways removed them as per your suggestion. So, my gains are no longer being prorated across these assets and they do not show up on Form 4797 as a Property. They were added to the sales expense. What do you mean by "Add them to the original cost basis and keep the entire sales price for the combined assets in one entry."  These don't show up anywhere, so not sure what it means by keeping the entire sales price for the combined assets in one entry .

- For some reason, the Form 4797, Line 1a is not being populated in TT. There are earlier threads saying that it may be a bug in TT. I have gone ahead and entered manually the Gross Sale Price from 1099-S. I figured that IRS will be getting this form, so it makes sense. If this shouldn't be done, let me know.

- For one of the assets, TT asked me to "Enter the amount of additional depreciation deducted after 1975". This asset had an amount in the "Special Depreciation" column, and I entered this amount in additional depreciation. Hopefully, this is accurate.

- Going through all the steps, and the suggestions in your email, I think disposing each asset with a gain (when there is an overall gain) is the only method that should be used. You had also mentioned earlier that:

The IRS requires that the selling price be proportionately prorated to arrive at a selling price for each 'piece' of a rental property since many assets can be placed in service at different times, such as your roof.

So, entering the Home and Land directly within the Sale of Business Property section, is not entirely accurate. You MAY reach the same gain/tax, but the expectation is to show a gain against all assets and the only way to do it is from the Rental section. The challenge is for people in my situation where the Rental Basis < Purchase price. This will be true for most people buying the property prior to 2008 and putting it up for rental after few years. So, adding Purchase Price - Rental Depreciation Basis to the Sales  expense is a common situation.

[AB-Tax]

@DianeW777 , any comments on my queries. I know these are probably trivial, just want to make sure that I am doing it correctly. 

For Point1, there are many train of thoughts as to how the HVAC and appliance purchased in March 2022, should be disposed. Some say it should just be added to the rental basis, as you have suggested (and what I have done). Others suggest to enter them in the asset section (even if there is no depreciation) and somehow show a gain for a minimal amount. But I am not sure how that can be done without actually prorating the gains and the expenses as per your above formula. Hence, I want to make sure that you did not mean anything else by "Add them to the original cost basis and keep the entire sales price for the combined assets in one entry." 

Point 2, is mostly informational and it seems it is a know bug. TT does not seem to consider it as an override, so hopefully I am able to E-File

Point 3 - When asked to "Enter the amount of additional depreciation deducted after 1975" for one of the assets, adding the "Special Depreciation" amount does not seem to have any effect on the taxes. It only shows up in Line 26a on Form 4797.