Primary Residence Sale With Partial Rental

Technical topics regarding tax preparation.
#1
JCCPA  
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New Client has come to me with a sale of their primary residence. They've lived there for approximately 20 years. Gain is less than $500,000.

About 10 years ago, they re-built part of their property and started renting out a separate living unit.

They never took depreciation on the separate living unit, but reported on Schedule E, all other income and expense, including allocation of mortgage interest and R/E Taxes.

Am I correct in assuming that they need to recognize gain on the sale of their property, for the rental portion only, via depreciation recapture, even though they never took depreciation expense?

TIA for any confirmations and related shared information.
 

#2
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JCCPA wrote:Am I correct in assuming that they need to recognize gain on the sale of their property, for the rental portion only, via depreciation recapture, even though they never took depreciation expense?

Yes, you are correct. However, they can file Form 3115 and claim all of the missed depreciation on Sch. E as a sec. 481(a) adjustment. The Designated Change Number is "107".
 

#3
EZTAX  
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Is the "seperate living area" attached to the home?
 

#4
JCCPA  
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Thank you, NoCal !!!!

I am reading through The Form 3115 and Intructions :).

Also, I'm reading a few other Posts and Links here that I have found.

I assume that by Filing Form 3115, we are able to take all of the missed Depreciation in the Year of Sale.

A Post I'm going through, has more about this re: not having to recognize depreciation as Recapture and avoiding higher rates.

I'll try to Embed that Post,

viewtopic.php?f=8&t=24636

Thank you so much for pointing me in the right direction.
 

#5
JCCPA  
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EZTAX wrote:Is the "seperate living area" attached to the home?


Hi EZTAX, thanks for chiming in.

No, it is a detached Barn that was converted to a separate living area.

I understand there are different rules if, say, they are renting out rooms in an existing footprint?

Please excuse my lack of knowledge in this area....!

If anything, the long hours of Tax Season are an opportunity to learn :).
 

#6
EZTAX  
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Correct, my understanding that if not a seperate structure it is treated similar to an office in home. No allocation is necessary regarding the gain but need to pay tax on depreciation taken (maybe not if price has gone down but it has been awhile since I have had to pay attention to those rules.)
 

#7
JCCPA  
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Thank you, EZ :).

This is one area of Tax Law that I need to bring myself up to a better level of understanding....

....I appreciate your Input, as well as NoCal's!
 

#8
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JCCPA wrote:it is a detached Barn that was converted to a separate living area.

As a detached barn that they were renting out, you need to apportion the sale between the two properties, the principal residence and the rented barn. The sale is treated as a sale of two different properties because the barn was a detached structure. See Reg. 1.121-1(e).

If the rented portion was within the dwelling unit, then only the portion of the gain allocable to allowable depreciation would have been taxable. See sec. 121(d)(6) and Reg. 1.121-1(d).
 

#9
EZTAX  
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NoCal -can you expand on the term "within the dwelling unit"? Would a basement apartment with its own batrhoom and entrance be considered "within the dwelling unit" or is it refering to a shared rental arrangement where a room is being rented in a home and kitchen is shared? In other words can we consider a dwelling unit to be a single structure or? Appreciate your thoughts.
 

#10
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EZTAX wrote:NoCal -can you expand on the term "within the dwelling unit"? Would a basement apartment with its own batrhoom and entrance be considered "within the dwelling unit" or is it refering to a shared rental arrangement where a room is being rented in a home and kitchen is shared? In other words can we consider a dwelling unit to be a single structure or? Appreciate your thoughts.

Read Reg. 1.121-1(e), and in particular, Example 3.
 

#11
EZTAX  
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Spot on, thanks for the education!
 


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