Sale of a 2 Family

[Kram BergGold]

My client has a 2 family house. Floor 1 has been rented for 20 years so the basis is very low. Floor two has been her primary residence for this 20 years. If she moves downstairs and lives there for 2 years she will pay tax on the sales price less expenses of sale and cost plus improvements less $250,000 plus depreciation. If there is a gain, does this avoid unrecaptured 1250 gain on the depreciation? If there is no gain due to Section 121, then I assume there is no 1250 unrecaptured gain, correct?

[Roland Slugg]

First of all, is the building a true duplex ... i.e. one containing two completely separate residences or flats? Or is it really a SFR that was "walled off" or otherwise structurally modified to create two private living spaces? If it's the latter, then I believe the entire sale will qualify as the sale of her primary residence. If so, the entire gain will qualify for the §121 exclusion, except for the depreciation taken (since May 7, 1997) on the portion rented out. Yes, that portion of gain would be treated as Unrecaptured §1250 Gain.

If the structure really is a duplex, I don't see how moving downstairs will accomplish anything. When she sells the building, she can only claim that one of the living units or the other was her principal residence, and the time limitation will prevent her from claiming the §121 exclusion twice in the same year. Thus, if the facts fit, it's much better to treat the structure as her personal residence, a portion of which was rented out.

[taxea]

My client has a 2 family house. Floor 1 has been rented for 20 years so the basis is very low. Floor two has been her primary residence for this 20 years. If she moves downstairs and lives there for 2 years she will pay tax on the sales price less expenses of sale and cost plus improvements less $250,000 plus depreciation. If there is a gain, does this avoid unrecaptured 1250 gain on the depreciation? If there is no gain due to Section 121, then I assume there is no 1250 unrecaptured gain, correct?

She would have to reside on both floors for the next two years or allocated the personal and "investment" portions of the residence.

[DonB]

TB 6-21,22: Post 5/6/1997 depreciation is recaptured unless there is no gain before section 121 exclusion.

[TaxGuyBill]

As Roland pointed out, unless she were to sell only part of the building at a time, she can only use one exclusion every two years. As two separate "dwelling units", it is treated as two separate sales of homes, even if it is just a 'walled off' single home. As such, she can't claim two exclusions at once for two sales of homes ("dwelling units").

Even if it was sold as two separate sales that were two (or more) years apart, you are forgetting that she would not qualify for the full $250,000 exclusion on the rental portion. The rental period after December 31st, 2008 would be "nonqualified use", so the $250,000 exclusion would be prorated and reduced.

In direct answer to your question, as Don pointed out, the 121 exclusion would not eliminate most of the deprecation. Unrecaptured Section 1250 Gain is based on the gain BEFORE §121, so it would still be taxed, regardless of any taxable gain or not.