Reporting Home Sale (Qualified Extended Duty and Rental)

My wife and I sold a house in June 2013. The home was purchased in 2000 and we lived in it for 2.5 years until 2003. From 2003 to present we have been on qualified extended duty for the U.S. Government. Likewise, the property has been rented out since we departed. It was depreciated using the 27.5 year straight line method.

At the sale, I was asked if the property had ever been used for income. Answering affirmatively, I subsequently received a 1099-S. My question concerns properly reporting the sale because I received the 1099-S. It should reflect that I do not owe capital gains tax (the gain was less than $500K) and I met the 2 out of 5 year rule due to the qualified extended duty. I do need to pay the depreciation recapture.

I suspect I need to fill out some variation of form 4797 or 8949. How do I do this correctly to reflect no capital gains tax and correct depreciation recapture?

Answer :

Recapture involves taking the prior depreciation deductions back into income, and it occurs at the sale of a property.As you said, as your pty was rented out before you sold it, you need to recapture unrecaptured depre (it is neither Sec 1245 nor sea 1250 depre) as ordinary income taxed at 25%UNLESS your marginal tax rate is lower than 25% when you dispose of the pty; tax rules authorized an exclusion only for the portion of the profit attributable to the residence part, prohibiting any exclusion for profit on the rental part. Recaptured depreciation is taxed at a maximum rate of 25 percent instead of the top rate of 15 percent for long-term capital gains, plus applicable state income taxes. You need to report this recaptured amount on Sch D of 1040/ form 8949, not Form 4797 . On the plus side, you suffer no recapture of other expenses, such as real estate taxes and mortgage interest.

To qualify for relief from recapture, you have to show by “adequate records or other evidence” (usually, past returns should be sufficient) “that the depre deduction allowed was less than the amount allowable.” Then the amount that “you cannot exclude is the amount allowed.To illustrate, assume that your rental home qualified you to claim depreciation, but you can show that you never claimed any. Then there is no reduction of the exclusion amount and no recapture.

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