Depreciation Recapture

[Maria]

Hello,

A client sold his home in 05. The 2 years our of 5 residency test was met, but he used part of the home for business purposes and took depreciation of about $20,000. Does the $20,000 recapture as taxable long-term capital gain? Do I need to prepare form 4797?

Thank you.

[jainen]

Not 4797

Not 4797. Use Schedule D to report the sale price and basis, with the exclusion amount below that netting to $20,000. Carry that amount down to lines 15 and 16, and also put it on Line 19. As section 1250 gain, it has a maximum tax rate of 25%.

[Jan]

recapture

If you use the property for business in the year of sale, then you would use form 4797, which then carries to Sch. D. line 11,15,16 and 19.
If you did not use the property for business in the year of sale, then use Sch. D, only.
This is the way my software does it (Lacerte) there will probably be arguments on doing it this way---I don’t think it matters which way you report it, the answer will be the same.

[Jan]

Reading Pub. 523, if you don’t use a separate part of property for business, then you don’t have to use form 4797 (like Jainen said in above post). Just use Sch. D, I don’t know why Lacerte use form 4797 when business is use in same year property is sold.

[OldJack]

I don’t know why Lacerte use form 4797 when business is use in same year property is sold.

I believe the "use of property in the year of sale" concept for residential property was never in the tax code, rules, or regulations. It was simply a concept for argument with the IRS under the theory that the property had been removed from business classification to the individual personal residential classification for later taxation. With the new code §121 tax-free on the sale of residence and recapture of depreciation on 1040 sch-D, that concept no longer is applicable. Your software is probably trying to report, on f4797, a separate business building on the same property as the residence?

[OldJack]

If you use the property for business in the year of sale, then you would use form 4797, which then carries to Sch. D. line 11,15,16 and 19.
If you did not use the property for business in the year of sale, then use Sch. D, only.
This is the way my software does it (Lacerte) there will probably be arguments on doing it this way---I don’t think it matters which way you report it, the answer will be the same.

Recapture of residential depreciation gain may make a big difference between 1040 Sch-D (long-term Capital gain line 19 [25%]) reporting verses form 4797 (long-term to 1040-Sch-D or Ordinary income if line 8 nonrecapture §1231 losses).

Any long-term gain (§1231=4797) on form 1040-4797 must first be applied to any prior 5 year ordinary losses (line 8, nonrecaptured §1231 losses) before it passes to 1040 Sch-D. Therefore if there were any prior 4797 losses deducted as ordinary loss (line 8) any 4797, Part 1, gain is first applied as ordinary income on 1040, page 1, line 14, instead of 1040 Sch-D.

Line 8
Your net section 1231 gain on line
is treated as ordinary income to the
extent of your “nonrecaptured section
1231 losses.” Your nonrecaptured
section 1231 losses are your net
section 1231 losses deducted during
the 5 preceding tax years that have
not yet been applied against any net
section 1231 gain to determine how
much net section 1231 gain is treated
as ordinary income under this rule.

[Jan]

Recapture of residential depreciation gain may make a big difference between 1040 Sch-D (long-term Capital gain line 19 [25%]) reporting verses form 4797 (long-term to 1040-Sch-D or Ordinary income if line 8 nonrecapture §1231 losses).

Your right OLDJACK--if you had some §1231 losses- it would make a difference.
I was just illustrating an example using Lacerte with a home sale with no §1231.

[Maria]

Thank You

Thanks everybody.

I use ProSystem. First I was trying to prepare a form 4797 like in the case of disposal of a piece of depreciable equipment/rental property, but the Prosystem seems not working since I have to incorporate all the input forms D-6, D-2 and DP-1.

Thanks for OldJack's thourough thinking. Now I realized why ProSystem carry Section 1231 loss forever even though the loss has been deducted.

Have a good day.

[OldJack]

Now I realized why ProSystem carry Section 1231 loss forever even though the loss has been deducted.

It carries the prior 4797 (business) losses forward (because you deducted them against ordinary income) 5 years "only" for the reason to keep you from having a 4797 (business) gain go to 1040 Sch-D for capital gains rate.