Sale of rental that qualifies for exclusion

[mbigelow]

Client used single-family residence as rental property for a couple years, sold it in 2016. Satisfies ownership/use tests and hasn't previously used the exclusion. Therefore, the only gain is on the depreciation allowable during rental period. Question is how to report it? I don't think 8949 applies b/c there's no taxable gain and that I only need to use a 4797. The only way I can see to get the figures to show correctly (i.e., with the depreciation as the only taxable gain) is to make basis adjustments to the building and land in the fixed assets module in order to exclude the gain not attributable to depreciation. I get the feeling I'm doing something out of whack. BTW, I use ATX tax software. Any advice is much appreciated. Thank you.

[Rapid Robert]

Question is how to report it?

This question comes up periodically, so you can probably search for results. In short, you show the Sec 121 exclusion as a negative number in Part I of Form 4797. I think it even says this somewhere in an IRS publication or form instruction.

[Roland Slugg]

Therefore, the only gain is on the depreciation allowable during rental period.

Greetings. Your statement quoted above is probably incorrect. The law was changed several years ago and now taxes more of the gain on the sale of a taxpayer's residence even if it qualifies for the $250k/$500k exclusion. In most cases, any business or rental use after 2008 will now result in some of the gain being taxed, in addition to all the depreciation taken after May 6, 1997. The business or rental use after 2008 is called "non-qualified residence use," resulting in an allocated portion of the gain, called "non-residence gain," being ineligible for the exclusion.

I use both ATX and Proseries, so I believe I can advise you how to report the sale on ATX. Start on F-8949. There is a tab called "Sale Principal Residence Input." Complete that screen in its entirety. The calculations will appear on the next tab over, "Sale Principal Residence Calc." From there the gain will flow to F-8949, page 2, and then on to Schedule D. The depreciation taken after May 6, 1997 will also be classified as Unrecaptured §1250 Gain, and you will see it on Schedule D, line 19. Your client's tax will be calculated on the screen/tab for line 19, Schedule D.

If the residence was being used as rental property at the time it was sold, you start everything on the "Fixed Assets" screens instead of on F-8949. Either way, the end result should be the same.

[Rapid Robert]

I disagree with this: " In most cases, any business or rental use after 2008 will now result in some of the [non-depreciation-related] gain being taxed". Up to 3 years of rental activity after two years use as a personal residence has no effect on the Sec 121 exclusion. I assumed this to be the scenario presented, unless new facts are provided.

I don't know what ATX does, but IRS instructions for Form 4797 support what I recommended:

"If the property was held more than 1 year after you converted it to business use, complete Part III to figure the amount of the gain. Do not take the [Sec. 121] exclusion into account when figuring the gain on line 24. If line 22 includes depreciation for periods after May 6, 1997, you cannot exclude gain to the extent of that depreciation. On Part I, line 2, write “Section 121 exclusion,” and enter the amount of the exclusion as a (loss) in column (g)."

If ATX doesn't report it this way, shame on them.

[TaxGuyBill]

I agree with Rapid Robert.

We don't know all of the facts, I interpret the situation that it was the Principal Residence, then rented out after that, and sold as a Rental Property. Unless the taxpayer moved back into the home after the rental period, there is not Nonqualified Use. See §121(b)(5)(C)(ii)(I).

[mbigelow]

TaxGuyBill, you're correct, they owned it for several years, then rented it for a couple years right up until the sale in 2016. One of the exceptions to nonqualified use of the home after 2008 in Pub 523 and the code quoted by TaxGuy reads as follows:

"Any portion of the 5-year period ending on the date of sale or exchange after the last date you use the property as a main home (meaning you owned and lived in the house for at least 2 years from the 5-year period ending on the date of the sale)."

This describes their situation to a T, therefore, I conclude that the rental use does not count as "nonqualified use". However, I am still open to anyone's challenge or opposing interpretation of this.

Thanks for the feedback TaxGuy, Rapid Robert and Roland- your insights and tax knowledge are always greatly appreciated.