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Depreciation recapture after divorce?

Since it will someday affect a relative of mine, I was wondering how depreciation recapture related to home office expense is handled after divorce when the depreciated property is ultimately sold.

In this case Taxpayer (even while married) was and is the sole owner of the house. Spouse has a sole proprietorship and took a home office deduction including depreciation on that part of the house which was Spouse's home office. Taxpayer and Spouse filed jointly up to and including calendar 2017. Taxpayer and Spouse got a final decree of divorce in calendar 2018. Taxpayer had and has no ownership interest in Spouse's business. Sometime in the next few years Taxpayer is likely to sell the house.

Questions:

1) Was Spouse even allowed to take that depreciation in the first place given that Spouse had no ownership in the house? 1a) If not, what is supposed to happen with the open joint returns? I assume they should be amended, but what if Spouse (now ex-Spouse) refuses to cooperate?

2) What happens re: depreciation recapture when Taxpayer sells the house? Is Taxpayer stuck with the entire depreciation recapture and ex-Spouse gets off scot-free? Does the answer change at all if the depreciation shouldn't have been taken in the first place?

Reply to
Rich Carreiro
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Off the top, my guess is that taking the depreciation on prior joint returns was entirely proper; and yes, the taxpayer will be stuck with the recapture when he sells.

This is an issue that coulda/shoulda been addressed in the divorce decree. You can't change the way that the IRS views it, but you can make an "equitable adjustment" to the marital property settlement to account for it.

Reply to
MTW

And does the %age of the house that was the home office also get excluded from the capital gains exclusion?

In other words, say the basis of the whole house was $400,000, the home office was 10% of the house, $21,000 of depreciation was taken, and the house ends up selling for $650,000.

The original basis of the office was $40,000, the depreciated basis was $19,000, and the sales price allocable to the office was $65,000. IIRC, that means there will be will be $21,000 of recaptured depreciation taxed at max 25%, and $25,000 of "regular" capital gain. (Those are totally made up numbers and I haven't tried to make them self-consistent.)

So overall on the whole house there will be $21,000 of depreciation recapture and $250,000 of "regular" cap gain.

Will the entire $250,000 be excludable or will the $25,000 of "regular" cap gain allocable to the office be nonetheless taxable (at regular cap gain rates)? I.e. is the final result:

  • $ 21,000 of depreciation recapture taxed at max 25%
  • 5,000 of excluded cap gains not taxed at all
  • $ 25,000 of cap gains taxed at regular cap gain rates?

Thanks!

Reply to
Rich Carreiro

Under current rules you don't account for a separate gain or loss on the business portion. Instead you are simply stuck with paying tax on the lessor of the depreciation "recapture" or the overall gain on the house.

Reply to
MTW

Rich, aren't you really asking about the part of the gain on the eventual sale of the house that's not going to be eligible for the Section 121 [principal residence] exclusion because that part of the gain is attributable to depreciation that was previously allowed (or allowable), rather than the "depreciation recapture"?

My question/observation isn't really a tax question, but a terminology clarification. I note that you're describing this part of the gain as being taxed at a maximum of 25%, and I agree with that. It's known as "unrecaptured section 1250 gain" [rather than "depreciation recapture"] where I come from, and it gets *really special* treatment on the 1040.

And I'm pretty sure that this is where MTW chose not to go, and that he just put quotation marks around "recapture" instead!

Reply to
lotax

Yes, you hit the nail on its head!! :-)

Reply to
MTW

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