I have a client who has owned a home since 1970 in CA. In Mid June 2010 she had a stroke, became disabled and was never able to return to her home and has resided in a care facility. Her son converted the home to a rental at the beginning of 2012. The home was sold as business property in Nov. 2014. The five year lookback period for the exclusion of gain runs from early Nov. 2014 to Early Nov. 2009. Based on the Sec. 121 rules for someone who becomes disabled, she can still qualify for the $250,000 exclusion if it is available after any ineligible gain due to non-residential use is factored in. A 1099-S was issued for the sale of the home.
Following the rules for non-residential use, I determined the non-use factor by dividing non-use days over total ownership days. That factor was multiplied by the adjusted gain (gain less depreciation) to obtain ineligible gain. That was added to the depreciation to obtain the total ineligible gain. That was subtracted from the adjusted gain to obtain how much exclusion can be used. The amount was greater than $250K. Therefore, assuming I am on firm grounds, the full $250K is available to exclude gain.
The home was sold as business property and the gain was computed using the 4562 and 4797. This gain transferred to Schedule D and the recaptured depreciation fed Line 19 on the Schedule D and ultimately the Schedule D tax worksheet.
The problem: The $250K exclusion is typically entered on Form 8949 as a negative adjustment (Code H) to the sale of your home. If I do that, there is obviously no selling proceeds and no basis and I am left with a $250K loss that flows to the Schedule D and sticks out like a sore thumb on its own line. I don't know any other way to do this, so that is what currently sits in the CCH Taxwise software. I did complte two statements that were added to the return. One explaining her qualifying for the exclusion and one showing the above computation.
I checked everything I could find in the way of instructions from the IRS but they all assume that the sale is the sale of a main home that had or is having some business use. In other words, the home had some non residential use in the past or is currently being used as both a home and business.
Anyone see an issue with this before I efile? _____ Alan
Maybe I don't fully understand the problem (I'm retired...and half brain-dead as far as taxes are concerned). But in situations like this, if the home qualified for the 121 exclusion, I reflected it on the return as the sale of a "personal" asset on Schedule D rather than a "business" asset on Form 4797. I don't believe there is any need to prorate the gain between business and personal uses (again, you either qualify for the exclusion or you don't), but naturally basis must be reduced by allowed/allowable depreciation and 1254 "recapture" computed where applicable.
Again, I may be missing the boat here, but I very respectfully think/guess that you are overthinking this. :-)
I'm proud to be only one-quarter brain-dead but maybe you could try this: report the $250,000 exclusion on Form 4797 instead of Schedule D. Does that get you the right answer but present less of a conspicuous "come-and-get-me" target for the IRS? I would put the exclusion as near as possible to where the gain on the sale of the "rental property" is being shown. And maybe cross-reference the two entries somehow.
"..typically entered on Form 8949.." shouldn't dictate where *you* want to report *this* item on *this* return...
Better idea: See the instructions for form 4797, page 2, about 3/4 of way down the page, in the right-hand column, where the IRS tells us this:
"On line 2 of Form 4797, write "Section 121 exclusion," and enter the amount of the exclusion as a (loss) in column (g)."
And I hope you get the same answer, tax-wise, as what you got when you put the exclusion on Schedule D! I mean you damn well better get the same answer!
This (above) is exactly what I have done in a similar situation. Alan, I was a little confused in your final paragraph, when you used the term "business use", were you distinguishing from "rental use"? In this context, I think they mean the same thing.
The Unrecaptured Sec 121 Gain (due to depreciation) should still show up on Sched D pg 2.
I don't know how many times I read those instructions and my brain just didn't compute to put the $250K exclusion on the 4797. AT this rate I'll be brain dead by the last week of this season.
And... yes Mark I was using the term interchangeably.
Whenever you sell a home that has had mix use, Sec. 121 does not allow you to exclude any gain attributable to depreciation nor any gain attributable to the non-residential use. The IRS calls this the ineligible gain. In other words, if there is a gain, the gain belongs to the personal use as well as the non-personal use and is allocated by the ratio I explained in the original post. Once you obtain the ineligible gain you subtract that from the adjusted gain and you are left with the amount you can exclude subject to the $250K/$500K limits. In my real case, the allocation to non-personal use was a small percentage because the home had been owned for 45 years. After subtracting the ineligible gain the amount left over was $256K so the whole $250K exclusion was still available. I just couldn't figure out where to put it until I saw "lotax's" reply.
I think you may be correct so I went to the regs and the examples that are there.
From 1.121-1(e). See the part starting with "No allocation is required...". Reference to para. (d) is to the depreciation. The title says "Property used in part as a principal residence." It ends with no allocation required if the residential use and non-use are in the same dwelling unit. Example 2 includes renting out the entire home as well as a building that was never used as a residence. No gain is allocated to the home even though it was during the lookback rented out. ======================================================================(e) Property used in part as a principal residence? (1) Allocation required. Section 121 will not apply to the gain allocable to any portion (separate from the dwelling unit) of property sold or exchanged with respect to which a taxpayer does not satisfy the use requirement. Thus, if a portion of the property was used for residential purposes and a portion of the property (separate from the dwelling unit) was used for non-residential purposes, only the gain allocable to the residential portion is excludable under section 121. No allocation is required if both the residential and non-residential portions of the property are within the same dwelling unit. However, section 121 does not apply to the gain allocable to the residential portion of the property to the extent provided by paragraph (d) of this section. ======================================================================However, there are inconsistencies when one looks at IRS pub 523 on this as well as the 4797 instructions. This is what triggered my calculations.
From page 10 of Pub 523 in order to determine whether the space remains business or rental space for purposes of the gain allocation: ======================================================================Determine whether the business or rental space still counts as a business space.
A space formerly used for business is considered residence space if ALL of the following are true: You were not using the space for business or rental at the time you sold the property, You did not earn any business or rental income from the space in the year you sold your home, and You used the space as residence space for 2 years out of the 5 years leading up to the sale. ======================================================================My client's home fails the ALL test as there was rental income and it was a rental at the time of sale.
From the 4797 instructions where it discusses sale of your home. Look at the last sentence starting with "However" and the reference to after
12/31/2008 and the use of the words "may not". The regs are from 2002. =====================================================================Exclusion of gain on sale of home used for business. You may be able to exclude part or all of the gain figured on Form 4797 if the property sold was used for business or to produce rental income and was also owned and used as your principal residence during the 5-year period ending on the date of the sale. During that 5-year period, you must have owned and used the property as your personal residence for 2 or more years. However, the exclusion may not apply to the part of the gain that is allocated to any period after December 31, 2008, during which the property was not used as your principal residence. ====================================================================My client's home was not used as the principal residence for a period after 12/31/2008. Nor was it the principal residence at the time of sale.
So.... it was time to go back to Public Law 110-289 (Housing and Economic Recovery Act of 2008). This is the statute that eliminated the so-called loophole in the law and added the changes to Sec. 121(b) as a revenue offset.
From the JCT explanation: ==================================================================For purposes of determining periods of nonqualified use, (i) any period after the last date the property is used as the principal residence of the taxpayer or spouse (regardless of use during that period), and (ii) any period (not to exceed two years) that the taxpayer is temporarily absent by reason of a change in place of employment, health, or, to the extent provided in regulations, unforeseen circumstances, are not taken into account. ==================================================================That seems pretty clear to me. Additionally, I looked at the CCH briefing that explained that change. =================================================================This new income inclusion rule applies to home sales after December 31,
2008, and, under a generous transition rule, is based only on nonqualified use periods that begin on or after January 1, 2009. In further relief from this new loophole closer, a period of absence generally counts as qualifying use if it occurs after the home was used as the principal residence. ================================================================== So I have concluded that your reference to 121(b)(4 [sic 5])(C)(ii)(I) is proper and that no allocation of gain is required to the rental period.
I have also concluded that per the 4797 instructions, the sale and the exclusion of gain has to be reported on that form because it was rental property at the time of the sale.
I publish the above for anyone else out there that is confused by these rules.
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