Is this residence transfer tax-free?

That looks to me like a textbook example of a sham transaction, one with no economic purpose other than to avoid taxes. I wouldn't do it.

I really wouldn't do that.

There are special rules for transfers of property between spouses. See 26 USC 1041. Preview:

General rule: No gain or loss shall be recognized on a transfer of property from an individual to (or in trust for the benefit of) a spouse ...

I haven't gone back to check the statute, but my recollection is that the time requirement must apply to both spouses to get the $500,000 exclusion. Only the ownership requirement is changed.

As John said, it won't get her what she wants. The sale is a sham.

If it's a sham sale, no.

No.

In addition to the two answers you already received.... your profit attributable to the depreciation (allowed or allowable) cannot be excluded. So.... all the profit would not be tax-free.

Right. And not only is it not tax free, but it's ordinary income rather than capital gain.

Is all the depreciation recaptured as Ordinary Income? Or just depreciation in excess of straight-line depreciation?

I'm pretty sure that all the gain attributable to depreciation will not be eligible for the Section 121 exclusion, but only the part that's in excess of straight-line [if there is any] will be recaptured as ordinary income. The rest of the depreciation [i.e., probably all of it] will be taxed as *unrecaptured section 1250 gain* which is really a section 1231 gain with a different - higher - tax rate than plain ol' long-term capital gain.

Which totally skips right past the "periods nonqualified use" and the gain allocable to those periods, which is (like the gain from depreciation taken) not eligible for the exclusion...

Piece of cake, huh?

I believe this reply contains an error. The recaptured depreciation called unrecaptured Section 1250 gain is taxed as ordinary income. You can see this by looking at the Schedule D Tax Worksheet. That recaptured amount is not treated as a long-term capital gain in the tax calculation. It gets treated as ordinary income. I agree that the amount of gain that can not be excluded is the sum of the recaptured depreciation and the amount of gain attributable to the period of nonqualified personal use.

The OP can look at IRS Pub 523, Sale of Your Home for worksheets that help you compute the taxable gain.

Please consider what I just wrote [about gains recognized, or not] to be subject to the huge caveat in this thread regarding sham transactions designed to avoid/evade income tax.

I'll humbly disagree with that disagreement. The way I see it is that "unrecaptured section 1250 gain" is a subcategory of section 1231 gain and is first netted with other section 1231 gains and losses and then is netted with other long-term capital gains, and if any of it survives the netting process, it's subject to the "special" tax rates for unrecaptured section 1250 gain. Please show me where that is wrong.

It's a capital gain and it's being subject to the special 25% tax rate limitation of IRC section 1(h)(E)(i). As such it's shown in Part II of Schedule D and also on Form 8949.

If it were ordinary income, none of all that confusing, circular, if-then-but-only-if-not-greater-than stuff would be necessary. The tax rate is capped at 25% for the unrecaptured section 1250 gain; otherwise it's just another long-term capital gain.

Run some numbers if that'll help. You won't be able to get the unrecaptured section 1250 gain to be taxed at any rate higher than 25%, which is what would happen if it were taxed as ordinary income!

Well.... this recapture on your main home is going to wind up on Line 12 of the unrecaptured 1250 gain worksheet. It will then find its way to Line 19 in Part III of the Schedule D. This will then force you to use the Schedule D Tax Worksheet to compute gain. Rather than walk you through the lines of that worksheet which will ultimately include the recapture amount as ordinary income, I direct your attention to the following words included with the how do you figure out the gain and exclusion on a home used for business worksheets in Pub 523.

If you used all or part of your home for business or rental after May 6,

1997, you may need to pay back (?recapture?) some or all of the depreciation you were entitled to take on your property. ?Recapturing? depreciation means you must include it as ordinary income on your tax return.

lotax is correct.

Okay, I fully agree with Alan when he writes: "*Recapturing* depreciation means you must include it as ordinary income on your tax return."

That's right, f'sure, but the stuff we're talking about here is called **UNrecaptured** section 1250 gain for a reason. It's called "UNrecaptured" because it's *not* recaptured, and it's *not* taxed as ordinary income, and it's *not* subject to the ordinary income tax rates. It's a special case of capital gain and it's **not** "recaptured" and it's *not* taxed as ordinary income.

There are some glitches in my prior post, some errors, but not this one.

Sorry if I might seem sorta negative about this... :)

This is where it all started:

"The recaptured depreciation called unrecaptured Section 1250 gain is taxed as ordinary income."

You are correct in pointing out that this statement is incorrect.

I got it. I forgot that it is only additional depreciation that is taxed at ordinary rates. Assuming there was no additional depreciation, then the gain that could not be excluded is taxed as capital gain using the netting procedure and the max rate set in section 1(h).

Let's go all the way back and answer the very first question, the one NadCixelsyd asked in the Original Post: "Is this kosher?"

My answer's "no." How about you?

I don't think there is any disagreement on that point.

Am I correct in that the term "maximum rate" here is a bit misleading? It is the only rate that pertains to unrecaptured 1250 gain. Nothing less, nothing more. Correct?

Yes, sec 1(h) sets the max rate at 25%.