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 Previous Page: Publication 523 - Selling Your Home - Excluding the Gain Next Page: Publication 523 - Selling Your Home - Reporting the SaleUse to find additional instances of index items. |
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You may be able to exclude your gain from the sale of a home that you have used for business or to produce rental income. But you must meet the ownership and use tests.
On May 29, 1998, Amy bought a house. She moved in on that date and lived in it until May 31, 2000, when she moved out of the house and put it up for rent. The house was rented from June 1, 2000, to March 31, 2002. Amy moved back into the house on April 1, 2002, and lived there until she sold it on January 30, 2004. During the 5-year period ending on the date of the sale (January 31, 1999 – January 30, 2004), Amy owned and lived in the house for more than 2 years as shown in the following table.
| Five-Year Period | Used as Home | Used as Rental |
| 1/31/99- 5/31/00 | 16 months | |
| 6/1/00 - 3/31/02 | 22 months | |
| 4/1/02 - 1/30/04 | 22 months | |
| 38 months | 22 months |
William owned and used a house as his main home from 1998 through 2001. On January 1, 2002, he moved to another state. He rented his house from that date until April 30, 2004, when he sold it. During the 5-year period ending on the date of sale (May 1, 1999 – April 30, 2004), William owned and lived in the house for 32 months (more than 2 years). He must report the sale on Form 4797. He can exclude gain up to $250,000. However, he cannot exclude the part of the gain equal to the depreciation he claimed for renting the house, as explained next.
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If you were entitled to take depreciation deductions because you used your home for business purposes or as rental property, you cannot exclude the part of your gain equal to any depreciation allowed or allowable as a deduction for periods after May 6, 1997. If you can show by adequate records or other evidence that the depreciation deduction allowed was less than the amount allowable, the amount you cannot exclude is the amount allowed.
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Dan sold his main home in 2004 at a $10,000 gain. He meets the ownership and use tests to exclude the gain from his income. However, he used one room of the home for business in 2003 and claimed $1,000 depreciation. He can exclude $9,000 ($10,000 – $1,000) of his gain. He has a taxable gain of $1,000.
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If you use property partly as a home and partly for business or to produce rental income, the treatment of any gain on the sale depends partly on whether the business or rental part of the property is part of your home or separate from it.
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If the part of your property used for business or to produce rental income is within your home, such as a room used as a home office for a business, you do not need to allocate the basis of the property and the amount realized between the business part of the property and the part used as a home. In addition, you do not need to report the sale of the business or rental part on Form 4797. This is true whether or not you were entitled to claim any depreciation deductions. However, you cannot exclude the part of any gain equal to any depreciation deductions allowed or allowable after May 6, 1997. See Depreciation after May 6, 1997 earlier.
Ray sold his main home in 2004 at a $30,000 gain. He meets the ownership and use tests to exclude the gain from his income. However, he used part of the home as a business office in 2003 and claimed $500 depreciation. Because the business office was part of his home (not separate from it), he does not have to allocate the basis and amount realized between the business part of the property and the part used as a home. In addition, he does not have to report any part of the gain on Form 4797. He reports his gain, exclusion, and taxable gain of $500 on Schedule D (Form 1040).
The facts are the same as in Example 1 except that Ray was not entitled to claim depreciation deductions for the business use of his home. Since Ray did not claim any depreciation deductions, he can exclude the entire $30,000 gain.
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You may have used part of your property as your home and a separate part of it for business or to produce rental income. Examples are:
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You cannot exclude gain on the separate part of your property used for business or to produce rental income unless you owned and lived in that part of your property for at least 2 years during the 5-year period ending on the date of the sale. If you do not meet the use test for the business or rental part of the property, you must allocate the basis of the property and the amount realized upon its sale between the business or rental part and the part used as a home. See Example 5, later, for an example of how to do this. You must report the sale of the business or rental part on Form 4797.
In 2000, Lew bought property that consisted of a house and a stable. He used the house as his main home and used the stable in his business for the next 4 years. He sold the entire property in 2004 at a $10,000 gain. Lew met the ownership and use tests for the house but did not meet the use test for the stable. Lew must allocate the basis of the property and the amount realized between the part of the property he used for his home and the part he used for his business, since the business part was separate from his home. Lew must report the gain on the business part of his property on Form 4797. He can exclude the gain on the part of the property that was his main home.
In 1999, Mary bought property that consisted of a house and a barn. Mary used the house as her main home and used the barn in her antiques business. In 2003, Mary moved out of the house and rented it to tenants. She claimed depreciation deductions on the house while renting it in 2003 and 2004. She continued to use the barn in her business. Mary sold the entire property in 2004 for a $21,000 gain. Mary must allocate the basis of the property and amount realized between the home and business parts of the property since the barn is separate from her home. She must report the entire gain from the barn on Form 4797 since she did not meet the use test for the barn. She must also report gain on the home to the extent of the depreciation she claimed for the rental.
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If you used a separate part of your property for business or to produce rental income in the year of sale, you should treat the sale of the property as the sale of two properties, even if you met the use test for the business or rental part. You must report the sale of the business or rental part on Form 4797.
To determine the amounts to report on Form 4797, you must divide your selling price, selling expenses, and basis between the part of the property used for business or rental and the separate part used as your home. In the same way, if you qualify to exclude any of the gain on the business or rental part of your property, also divide your maximum exclusion between that part of the property and the separate part used as your home. If you want to use Worksheet 2 (shown earlier) to figure your exclusion and taxable gain from each part, fill out a separate Worksheet 2 (Part 2) for each.
Taxmap/pubs/p523-004.htm#TXMP5aaf8a0b Excluding gain on the business or rental part of your property. |
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You generally can exclude gain on the part of your property used for business or rental if you owned and lived in that part as your main home for at least 2 years during the 5-year period ending on the date of the sale. If you used a separate Worksheet 2 (Part 2) to figure the exclusion for the business or rental part, do not fill out lines 10 and 11 of that Worksheet 2. Fill it out only through line 9. Then fill out Form 4797. Enter the exclusion for the business or rental part on Form 4797 as explained in the Form 4797 instructions. (Also see Example 5, next.)
If you have any taxable gain due to depreciation, you will need to use the Schedule D Tax Worksheet in the Schedule D (Form 1040) instructions, rather than the Qualified Dividends and Capital Gain Tax Worksheet in the Form 1040 instructions, to figure your tax. First, fill out the Unrecaptured Section 1250 Gain Worksheet in the Schedule D instructions. See line 11 of Worksheet 2.
In January 2000, you bought and moved into a 4-story townhouse. In December 2002, you converted the basement level, which has a separate entrance, into a separate apartment by installing a kitchen and bathroom and removing the interior stairway that led from the basement to the upper floors. After you completed the conversion, your townhouse had a rental unit that was separate from the part of your house used as your home. You lived in the first, second, and third levels of the townhouse and rented the basement level to tenants until December 2004. You claimed depreciation deductions of $2,000 for the basement apartment. You sold the entire townhouse in December 2004 for a $16,000 gain. Your records show the following.
| Purchase price | $ 96,000 |
| Depreciation (on rental part; all after 5/6/1997) | 2,000 |
| Selling price | 120,000 |
| Selling expenses | 10,000 |
| Home | Rental | |
| (3/4) | (1/4) | |
| Purchase price | $72,000 | $24,000 |
| Minus: Depreciation | -0- | 2,000 |
| Adjusted basis | $72,000 | $22,000 |
Next, to figure the gain on each part, you decide to fill out a separate Worksheet 2 (Part 1) for each part, dividing your selling price and selling expenses between the two parts.
| Home | Rental | ||
| (3/4) | (1/4) | ||
| Part 1 - Gain or (Loss) on Sale | |||
| 1) | Selling price of home | $90,000 | $30,000 |
| 2) | Selling expenses | 7,500 | 2,500 |
| 3) | Subtract line 2 from line 1 | $82,500 | $27,500 |
| 4) | Adjusted basis of home sold | 72,000 | 22,000 |
| 5) | Subtract line 4 from line 3. This is the gain or (loss) | $10,500 | $5,500 |
Then, to figure your taxable gain and exclusion, you decide to fill out a separate Worksheet 2 (Part 2) for each part, dividing your maximum exclusion between the two parts. You are single, so the maximum exclusion is $250,000.
| Home | Rental | ||
| (3/4) | (1/4) | ||
| Part 2 - Exclusion and Taxable Gain | |||
| 6) | Depreciation allowed or allowable after May 6, 1997 | $-0- | $2,000 |
| 7) | Subtract line 6 from gain figured earlier | 10,500 | 3,500 |
| 8) | Maximum exclusion | $187,500 | $62,500 |
| 9) | Exclusion (smaller of line 7 or line 8) | 10,500 | 3,500 |
| 10) | Taxable gain (gain figured earlier minus line 9) | -0- | * |
| 11) | Smaller of line 6 or line 10 | -0- | * |
| * Lines 10 and 11 do not need to be filled out for the rental part. | |||
Do not report the gain from the part used as your home, because you can exclude all of it. You report the gain from the rental part, $5,500, in Part III of Form 4797. You enter your exclusion, ($3,500), on line 2 of Form 4797. Your taxable gain from the rental part is $2,000 ($5,500 – $3,500).
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If you have used a separate part of your property for business or to produce rental income (though not in the year of sale) but meet the use test for both the business or rental part and the part you use as a home, you do not need to treat the transaction as the sale of two properties. Also, you do not need to file Form 4797. You generally can exclude gain on the entire property.
Assume the same facts as in Example 5, except that in March 2004, you combined the two separate dwelling units by eliminating the basement kitchen and building a new interior stairway to the upper floors. You used the entire townhouse as your main home for the rest of 2004. The entire townhouse was used as your main home for at least 2 years during the 5-year period ending on the date of the sale. You report the gain, $16,000, and the allowable exclusion, ($14,000), on Part II of Schedule D (Form 1040). Since your $2,000 taxable gain is from depreciation, it is unrecognized section 1250 gain, so you must also enter it on line 12 of the Unrecaptured Section 1250 Gain Worksheet in the Schedule D (Form 1040) instructions. You have no other amounts to enter on that worksheet, so you also enter $2,000 on line 19 of Schedule D. You then figure your tax using the Schedule D Tax Worksheet.
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