Unrecaptured 1250 Gain

[Kram BergGold]

I know that pre May 7, 1997 depreciation on a home office is not subject to Unrecaptured 1250 gain on the sale of a principal residence. What about pre May 7, 1997 depreciation from renting the principal residence? Is that subject to Unrecaptured 1250 gain. I know all depreciation has to be subtracted from basis.

[jmcdtax]

From the library of Office of Chief Counsel Internal Revenue Service Memorandum Number: 200630015 Release Date: 7/28/2006 CC:ITA:B04:MEBrookens POSTF-148456-05 UILC: 121.01-04 date: February 16, 2006 to: Associate Area Counsel (Kansas City) (Small Business/Self-Employed) Attn: Ms. Vicki L. Miller, CC:SB:5:KCY from: George F. Wright Assistant Branch Chief, Branch 4 (Income Tax & Accounting)

2. Is any portion of the gain attributable to depreciation deductions taken on the property prior to May 7, 1997, subject to depreciation recapture under ? 1250(a), and hence to inclusion in Taxpayers’ gross income in the 1997 taxable year?

CONCLUSIONS: 1. Taxpayers satisfy the requirements of ? 121(d)(9) and accordingly are entitled under ? 121(a) to exclude most of their gain on the sale of their property.

2. A portion of the gain attributable to depreciation deductions taken before May 7, --------, is subject to recapture under ? 1250(a) and must be included as ordinary income in Taxpayers’ ------- gross income.

[Rapid Robert]

So what's the answer, and is the OP correct about home office depreciation?

[Kram BergGold]

jmcdtax- I see a problem with this memorandum. It says the recapture is ordinary income. In the case of a home office, the issue I raise is how to deal with Unrecaptured 1250 gain which is subject to a 25% tax at most. Unfortunately, this memorandum seems to be dealing with Recaptured gain.

[TaxGuyBill]

I know that pre May 7, 1997 depreciation on a home office is not subject to Unrecaptured 1250 gain on the sale of a principal residence.

Not necessarily true.

It has nothing to do with a Home Office. It has to do with the Section 121 exclusion ($250,000/$500,000).

The rule is the Section 121 does not cover the gain due to post-May 6th, 1997 depreciation. In effect, that means it can cover gain due to pre-May 7th, 1997 depreciation (if the total gain is less the maximum exclusion amount).


For your question about renting, the same rule applies. If the taxpayer qualifies for the Section 121 exclusion, it can cover the gain due to pre-May 7th, 1997 depreciation.


That raises an interesting question that I may need to research sometime. If the Section 121 exclusion is allowed but does not cover all of the gain, can it exclude the Section 1250 gain 'first', or does it first cover the regular capital gain and the Section 1250 gain is excluded last? I never thought of it before.

[Kram BergGold]

I see what you are saying. I was totally confused. Post May 7, 1997 depreciation has nothing to do with unrecaptured 1250 gain. In this case there is $25,000 of pre May 7, 1997 depreciation . The gain is over $500,000 for a single person. So Section 121 is not an issue. She will get her full $250k exclusion. I assume I subject the $25,000 of depreciation to Unrecaptured Section 1250 gain treatment (taxed at 25%) and I am all set. Agree?

[TaxGuyBill]

So Section 121 is not an issue. She will get her full $250k exclusion.


I assume I subject the $25,000 of depreciation to Unrecaptured Section 1250 gain treatment (taxed at 25%) and I am all set. Agree?

I don't know the circumstances of your client, but if it was rented after 2008 while she was NOT living it in, you need calculate the Nonqualified Use to determine her exclusion. Based on your numbers though, it is very possible she would still qualify for the full $250,000 even if Nonqualified Use comes into play.

Probably? But as my original comment said, I'm not certain if the Section 121 exclusion can cover the 1250 'first' or if it covers the 'regular' gain 'first' and the 1250 gain isn't excluded until 'last'.

[Rapid Robert]

"I'm not certain if the Section 121 exclusion can cover the 1250 'first' or if it covers the 'regular' gain 'first' and the 1250 gain isn't excluded until 'last'."

First, to be sure I understand you, this only pertains to 1250 depreciation prior to the 1997 date, right?

I guess one question is, was there a special cap gains rate of maximum 25% prior to 1997? If not, then it doesn't matter, since it would all (regular gain and 1250 gain) be taxed as ordinary income.

I just spent 15 minutes trying to parse ?1(h)(6) and ?1250 and couldn't figure it out. It just highlights again all the ridiculous complexity of our tax code. I mean, why should there be special rate for Sec 1250 gain anyway? Just tax it as ordinary income, since the depreciation was deducted against ordinary income.

[TaxGuyBill]

First, to be sure I understand you, this only pertains to 1250 depreciation prior to the 1997 date, right?

I guess one question is, was there a special cap gains rate of maximum 25% prior to 1997?

If not, then it doesn't matter, since it would all (regular gain and 1250 gain) be taxed as ordinary income.

Yes.

It doesn't matter what the tax rates were then, what matters is now.

It does matter: Simplified example:


Purchased home for $100,000. Sold home for $800,000. Pre-1997 depreciation $50,000. Exclusion $500,000. Total gain $750,000 ($700,000 profit and $50,000 due to depreciation). Regular tax bracket 24%; Long-term capital gain tax bracket of 15%.

Scenario #1: Does the $500,000 exclusion result in long-term capital gain of $200,000 ($700,000 profit minus $500,000 exclusion), and $50,000 of 1250 gain. Resulting in 15% x $200,000, plus 24% x $50,000?

Scenario #2: Or can the $500,000 exclusion result in long-term capital gain of $250,000 ($700,000 profit minus $450,000 exclusion) and $0 of 1250 gain ($50,000 of the exclusion eliminated that). Resulting in 15% x $250,000, plus 24% of $0?


I suspect the first scenario is the correct reporting, but I'm not sure (and have not research it).

[Rapid Robert]

It doesn't matter what the tax rates were then, what matters is now.

I know. I didn't express myself very clearly. I was suggesting that at present, maybe the special cap gains rate for Sec. 1250 gain does not apply to 1250 gain prior to 1997. Same way for example as under today's tax law, alimony prior to 2017 (or whatever) is taxable, but not after that date.

But I have no cites to back that up. As I said, I tried to follow the code but it was spaghetti to me. Doesn't it seem odd, however, that the scenario you describe wasn't resolved back in 1997? I wish I had been a tax pro back then, I'd have some reference material.

That memo referenced in post #2 has a lot of discussion about pre and post 1997 treatment but I still couldn't find any clear guidance.

https://my.kiplinger.com/members/taxlinks/082506/0630015.pdf

[TaxGuyBill]

maybe the special cap gains rate for Sec. 1250 gain does not apply to 1250 gain prior to 1997.

Doesn't it seem odd, however, that the scenario you describe wasn't resolved back in 1997?

At least under current law, the Unrecaptured ?1250 gain rate is the same regardless of when the depreciation was taken. The year 1997 only has to do with the sale of a Principal Residence (the rules changed from 'rolling over' the gain to the current ?121 rules). There were some possible references added back in 1997 to the 25% rate and 1997, but I haven't looked too deeply at that because it is not current law.


There could be guidance about it somewhere, but I haven't seen it. Or possibly be in some Proposed Regulation that never was implemented.

The changed law was almost thirty years ago and gains in excess of $250,000/$500,000 were less common, so maybe there wasn't a big 'push' for finding the answer.