Sale of Residence Previously Used as Commercial Rental Property

[Hoosier]

Client built a commercial building in 2013 to use as a warehouse for his business (1120S). Building is on separate land several miles away from his business. Client rented this commercial building to the 1120S and reported rent and depreciation on Sch E form 1040. In 2021, client sold his residence and then moved into this commercial building, thus this building became his residence (rent and depreciation stopped at this point). In late 2025 the client sold this commercial building/residence. He lived in the building exclusively as his residence from the fall of 2021 to the fall of 2025.

From 2013 to 2021, there was total accumulated depreciation of $15,897 that was reported on his 1040 Sch E and form 4562 (since the client owned the commercial building personally and collected rent from his 1120S business). Although the sale of the building qualifies as the sale of a residence and can claim the residence exclusion for capital gains, I would think that the accumulated deprecation should be recaptured and reported as income on the 2025 form 1040. I’m not sure how to report this but I would think it would be reported on form 4797 showing the $15,897 as income with zero cost basis and that the gain would be reported as ordinary income, not capital gains income.

However, I’m not for sure so hoping for a conclusive solution.

[TaxGuyBill]

Sale of a personal residence is supposed to be reported on Form 8949/Schedule D.

Besides the $15,897 gain due to depreciation, only PART of the rest of the gain can be excluded due to "Nonqualified Use". ROUGH numbers, it was his Principal Residence the last 4 years, but he owned it a total of 12 years. That means about only 4/12ths (1/3) of the gain (not including the gain due to depreciation) qualifies for the exclusion.

How exactly you enter that into your software depends on what software you use. I use ProSeries and all of that can be entered on the "Home Sale Wks".