Depreciation recaptured on primary residence

Forum|Forum|4 years ago
May 14, 2021
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We sold our primary residence in 2020. We lived in the house over 2 years out of the last 5 prior to the sale and have owned it for 20+ years. We should qualify for the $500,000 exemption for sale of primary residence.

In 2015 we rented the house for a few years while we travelled, and took depreciation deductions. The renters moved out 8/1/18 and we moved back in 8/1/18. We lived in the house until the end of November 2020 when we sold the house.

I understand we need to reduce the basis of the house by depreciation taken, which increases our gain. However, the gain is still way under the $500,000 exclusion when you sell your primary residence. Since I reduced the basis by the amount of depreciation, that is in effect recapturing the depreciation. Why does TurboTax add that same depreciation into our ordinary income. Taxing it twice in a way. Turbo Tax is reporting the depreciation amount on Schedule D along with our other Capital Gains, but then that amount is pulled out during the tax calculation and taxed as regular income. Why? I already recaptured the depreciation by subtracting it from our basis, thereby increasing profit. The profit is still below the $500,000 exclusion amount.

If the depreciation is recaptured twice, both by reducing basis and taxed as ordinary income, does CA Franchise Tax Board (FTB) also tax the same amount? I asked in an FTB Chat whether they recaptured depreciation if the gain is under the $500,000 exclusion. Their response was "We do not include that as taxable income because it is still within the excludable amount. You can make an adjustment on Schedule CA". TurboTax transfers the depreciation amount as taxable to the California return. So, which is correct?

CA conforms to IRS Sale of Residence rules. Doesn't that mean it is also not taxed on the Federal return?

Thank you,

Sue

Not A Product Question

AmeliesUncle

@smitchells wrote:
In 2015 we rented the house for a few years while we travelled, and took depreciation deductions. The renters moved out 8/1/18 and we moved back in 8/1/18. We lived in the house until the end of November 2020 when we sold the house.

Why does TurboTax add that same depreciation into our ordinary income. Taxing it twice in a way. Turbo Tax is reporting the depreciation amount on Schedule D along with our other Capital Gains, but then that amount is pulled out during the tax calculation and taxed as regular income.

How much is your total gain? The fact it was rented out and then you moved back into it means your gain is prorated because you have "Nonqualified Use". If your total gain is less than $500,000, it would NOT all be able to be excluded and you will owe some tax (in addition to the depreciation).

It is not being taxed twice (unless you entered something incorrectly). As you said, it is being pulled OUT of your capital gains and taxed at your regular tax rate (up to 25%). So if your tax return shows $30,000 of capital gains, of which $20,000 are from depreciation, it would tax $10,000 at the capital gain rates and $20,000 at your regular tax rate (up to 25%).

smitchellsAuthor

From what I read "nonqualified use" only applies if our original use on the home was a rental, and later we converted to a personal residence. To prevent people from moving into their rental properties for two years just to get the $500,000 exclusion. We lived in the home from date of purchase for 20 years before renting it for three.

If you decrease basis by depreciation, increasing your gain (which you are taxed on if over $500,000), plus you recapture that same amount and pay an additional 25% tax on that as ordinary income (even if gain is way under the $500,000), you are basically paying tax on the same amount twice.

It feels like double taxation to me.

Anyways, is this accurate? Is depreciation both subtracted from basis AND added to ordinary income? I was hoping I was doing it wrong!

Does California conform and tax it the same?

Thanks

AmeliesUncle

@smitchells wrote:
From what I read "nonqualified use" only applies if our original use on the home was a rental, and later we converted to a personal residence.

If you decrease basis by depreciation, increasing your gain (which you are taxed on if over $500,000), plus you recapture that same amount and pay an additional 25% tax on that as ordinary income (even if gain is way under the $500,000), you are basically paying tax on the same amount twice.
It feels like double taxation to me.
Anyways, is this accurate? Is depreciation both subtracted from basis AND added to ordinary income? I was hoping I was doing it wrong!
Does California conform and tax it the same?
Thanks

Nonqualified Use applies if it was a rental (or anything other than your Principal Residence) before it was your Principal Residence. It does not matter what the "original use" was. You said you moved back into the home in 2018 (after it was rented), and that triggers it to be Nonqualified Use.

As I said before, it is not taxed twice. Maybe an example will help:

Let's say you bought the home for $300,000, took $100,000 of depreciation, and sold it for $500,000.

Your total gain is $300,000 (Sales Price of $500,000 minus your Adjusted Basis of $200,000). OF that $300,000 gain, $100,000 is Unrecaptured 1250 Gain (tax due to the depreciation), and the other $200,000 is taxed as long-term capital gain.

So even if you had $0 depreciation, you would pay tax on the $200,000. But because you had $100,000 of depreciation, you pay tax on that $100,000 when it is sold. It is only taxed once.