TurboTax Unable to Handle Full Depreciation Recapture on Home Sale?

[user17710097333]

TT cannot accurately report depreciation recapture from both current rental depreciation and past home office depreciation on the sale of a section 121 primary residence.

Details:  We purchased home in 2018.  We lived there as primary residence until January 2024.  For each year lived there (2018-2023), we took itemized home office deductions, including depreciation on the portion of the house used as a home office, reported on Schedule C and line 42 of form 8829.  On 1/31/2024,  moved to a different state and put house into service as rental.  Rented out entire house until 7/17/2025.  Sold house on 7/17/2025.  House qualifies for section 121 exclusion with the exception of the depreciation recapture from two sources:  1) home office depreciation on form 8829 line 42 from 2018-2023 and 2) rental depreciation on Schedule E in 2024 and 2025.

Regardless of whether I report the 2025 home sale in Schedule E *or* Sale of Main Home, TT accurately links the rental to the Home Sale Worksheet.  However, TT only reports the depreciation from the rental.  Even if I manually override the total depreciation taken on (or eligible) for the home in the Sale of Main Home section in order to enter the amount that reflects *both* the home office depreciation and the rental depreciation, the software automatically corrects it and defaults back to the combined 2024 and 2025 Schedule E rental depreciation only.

The end result is that I cannot get Form 4797 to accurately reflect the total depreciation amount.  It underreports the amount by excluding the depreciation total from the home office depreciation and only recognizing the rental depreciation.

Please help.

[DianeW777]

In your situation the sale should be reported as a sale of your home. This means that in the rental activity you must be sure to select in Property Info it was sold and when prompted select Special Handling (this stops TurboTax from looking for sale information in the rental).

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, include the total depreciation used as a home office as well.  Check your prior tax returns for this figure from both the rental and the home office.
2. The number of days the property was available for rent during the ownership period.

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 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

Steps to enter the Sale of Home in TurboTax: Wages and Income > Less Common Income > Sale of Home

1. On the screen Primary use of home select 'Yes'
2. Enter the number of days used as a rental (nonqualified use)
3. Continue to Depreciation after May 6, 1997 > Enter the total depreciation for rental and home office in both boxes

This will allow TurboTax to handle the sale with the correct amount of taxable gain and excluded home sale gain. 

@user17710097333 

[user17710097333]

Thank you for understanding my situation and trying to help.

My concern with your suggested workaround is that it requires me to enter days of nonqualified use.  However, there are zero days of nonqualified use because the rental occurred after we completely moved out of our primary home, and the home was sold while still in the section 121 exclusion period. 

I am also concerned that if I follow this workaround, the passive losses from the rental from 2025 (and carryover passive losses from 2024) will not be released to offset the depreciation recapture amount.

Please advise.

[DianeW777]

There is nonqualified use of your home for every day it was available for rent. This is specifically referring to rental activity which is 'nonqualified' time that must be accounted for when making sure you get the full amount allowed for the home sale exclusion. There will be a taxable amount of the gain due to the nonqualified use. This is not new tax law. 

• IRS Publication 523

If you enter the passive loss carryover as instructed it will be included as part of your rental activity loss for the year of sale. The full amount remaining in the year of sale is used on your Schedule E and will carry directly to the Form 1040.

@user17710097333 

[user17710097333]

Please see example 1, below, taken directly from TT's linked help section under the Schedule E question: "Did you use this home as anything other than your primary home?"

Very clearly it seems to be TT's take on settled tax law that rental of primary home after you move out is NOT nonqualified use as long as the home qualifies for Section 121 exclusion upon sale:

 

NONQUALIFIED USE OF A MAIN HOME

Simply described, "nonqualified use" means any use other than as a principal residence after December 31, 2008. So, for example, use as a second home, vacation home or rental is considered "nonqualified use" beginning in 2009 or later. However, "nonqualified use" does not apply to time that falls into one of the following categories:

1. Periods of time after its use as a principal residence.
2. Temporary absences due to a change in employment, health or unforeseen circumstances.
3. Any period (not to exceed 10 years) during which you or your spouse (if married) is serving on qualified official extended duty as a member of the uniformed services, the Foreign Service, the intelligence community, or as an employee or volunteer of the Peace Corps.

Here are a few examples:
1. After owning and living in it for several years, you move out of your main home on August 1, 2025, and rent it out for a year before selling it. The time it is rented out doesn't count as "nonqualified use" because it is AFTER being used as a principal residence.
2. You purchase a vacation home in 2008. It is not rented or used as a principal residence until August 1, 2025 when you move into it and make it your main home. A couple of years later, when this home is sold, the amount of time the property was not a main home after December 31, 2008, is considered "nonqualified use". In this example, the property was a vacation home between December 31, 2008, and July 31, 2025, and none of the exceptions apply, so that time must be considered "nonqualified use".

[DianeW777]

Yes, you seem to understand the rules. Your posted information is exactly what it means:

• Simply described, "nonqualified use" means any use other than as a principal residence after December 31, 2008. So, for example, use as a second home, vacation home or rental is considered "nonqualified use" beginning in 2009 or later. However, "nonqualified use" does not apply to time that falls into one of the following categories:
  
  1. Periods of time after its use as a principal residence.

The explanation about how to report is correct and some of the gain will be taxable based on using it as a rental property for a period and as a home office deduction. Depreciation recapture is required.

@user17710097333 

[user17710097333]

Thank you, Diane.  Yes, I understand that depreciation recapture is taxable.  But I cannot separately enter depreciation recapture from Schedule E rental from the year of sale and the year prior to sale and depreciation recapture from Schedule C (form 8829 line 42) from many years prior to use as a rental.  There is no way for me to do this in TT without erroneously categorizing my rental as nonqualified use, per the tax rules cited above.

Please advise on how I can get depreciation recapture from 2024-2025 Schedule E rental *and* depreciation recapture from 2018-2023 home office deduction onto section III of form 4797 so that I can be correctly taxed on it.

Note that I already have the depreciation totals calculated.  What I am missing is a way to enter those totals in TT's interview schedule in a way that it recognizes.

I have put over 40 hours of work into trying to get TT's interface to work with this set of tax facts.  I have spoken to over a dozen tax experts.  If you can help me resolve, I would be incredibly grateful.

[DianeW777]

Apologies if I misunderstood the key question. 

1. Report the sale of home only, after you follow the steps for each asset (home office and rental).
2. Once you reach this screen for each asset, you must select 'This item was sold, retired, stolen, destroyed, disposed of, converted to personal use....' 
3. Next enter the date you stopped using the asset for rental purposes. And answer 'Yes' you always used this asset 100% of the time for business. (The percentage of use doesn't change until after conversion from rental to personal use.)
4. Select 'Yes' for Special Handling due to 'You converted the asset to 100% personal use'. TurboTax will not try to report a sale here. 
5. Collect the total depreciation used all years for rental (Schedule E) and office (Schedule C). You may have to write down the accumulated amount for all prior years and then the amount for 2025. Add them together for the total amount.

@user17710097333