Research - sale of primary home, 50% rental, with home office?

[Sibley]

My parents are going to be selling their home in the next year or so. I do their taxes every year, but have no idea how to handle this situation.

Duplex, they live in half, rent out half. (Schedule E rental)
They have a home office (schedule C home office).
The house has been depreciated since they bought it, about 20 years ago.
Capitalized a new roof 2 years ago, that's been depreciating as well.

Tax basis is 180k +15k less depreciation, I can dig up more accurate numbers if needed.

So, how the heck would I handle selling this house for taxes? Unless I can figure it out, I'll be finding a CPA firm to do their taxes the year it sells. I'd like to run some scenarios to guesstimate taxes owed at the very least.

[ISawTheLight]

I think your parents have two separate residences - one personal unit, one rental unit.  They should have only been depreciating the assets relating to the rental unit (if we assume the units are the same size and the entire thing was purchased for $180k, then they should have been depreciating $90k of the original purchase price and 50% of the $15k roof replacement). 

The portion of the sales price relating to the rental (again, if the units are the same size, 50%) would be a taxable event, subject to depreciation recapture and capital gains.  The portion of the sales price relating to the personal residence should be a non-taxable event, except to the extent there is depreciation recapture from the home office.

If their personal unit is substantially upgraded from the rental unit you could probably allocate more of the purchase price to it than the square footage might suggest.

[Sibley]

That makes sense, thank you. you're right, only half should have been depreciated. I will have to look and confirm that it was setup that way. I know the roof should be ok.

[Lucky Recardito]

I think your parents have two separate residences - one personal unit, one rental unit.  They should have only been depreciating the assets relating to the rental unit (if we assume the units are the same size and the entire thing was purchased for $180k, then they should have been depreciating $90k of the original purchase price and 50% of the $15k roof replacement). 

A slight tweak here: my understanding is that they should have only been depreciating the rental's portion of the value related to the building. Land doesn't depreciate. I also own a two-flat; when I set up our depreciation schedule, I consulted the assessor's report to determine land vs. building value. So in a 50/50 use split, only a portion of the rental's 50% value (that apportioned to the building, not the land) should have been depreciating.

The portion of the sales price relating to the rental (again, if the units are the same size, 50%) would be a taxable event, subject to depreciation recapture and capital gains.  The portion of the sales price relating to the personal residence should be a non-taxable event, except to the extent there is depreciation recapture from the home office.

This matches my understanding -- though when I tried to sort out the tax treatment of a potential future sales, someone here pointed out that I was double-taxing some assets (applying depreciation recapture and capital gains to the same dollars), and I haven't yet figured out how to correct my math (not high on priority list... we plan to stay put for decades). I will try to find the thread to link here... EDIT: Here it is: https://forum.mrmoneymustache.com/taxes/tax-implications-of-owner-occupied-2-flat/msg1357094/#msg1357094

When you file taxes, do you use a program? In our first year of taxes in our home, I had carefully researched how to set the basis depreciate the rental, and had a spreadsheet prepped with all the numbers. I use the HR Block software to prep our taxes, and was pleased to find it had a wizard/widget to do exactly what I had done manually. I was happy to let it verify my assumptions and math. :-) My assumption is that it has similar logic built in to handle a sale of such an asset, since it was very competent at helping me get started. TL/DR: If you use tax software, this may turn out to be NBD.

[Sibley]

Yes, they're on HR Block. I'm not moving them out of it until after the house is gone and done with.

Looking at their 2017 return:

Form 8829 - Business use of home
The house is being depreciated here. Full purchase price, no exclusion for land. Now, since it's the home office a tiny % of the value is actually being depreciated, but it's still double the amount that should have been depreciated.

Schedule E
The house was put into service on 4/30/2002, cost 196k. Looks like basis was $84k after 2017.
New roof 5/1/16 at $15,257, basis $14.3k .

Both are straight line, 27.5 years.

In other words, dad didn't set it up right and I'll have to figure out what to do. I may just have them hire a CPA to sort it all out. I can do the rest and feed it to them and they just figure out the house sale stuff.

I'll make a copy of the 2017 file and play with it, put in some estimated numbers and see what I come up with. But yeah, this isn't looking good.

[Lucky Recardito]

Oy, yeah... that sounds like a puzzle -- it looks like they've been depreciating the whole property (not just the rental portion of the building), and maybe depreciating the office part twice (if they're depreciating the full property on Schedule E, and then a % for the office on 8829)? And also depreciating the roof fully, when that also should have been divided into rental/owner-occupied portions. I'd be interested to hear how this turns out, particularly if you engage a CPA!

[Rocketman]

Because you have been using an impermissible method of depreciation, you will need to file a “change of accounting method” form (#8830 I think) and recognize the income to get back to the correct accumulated deprecation. Talk to a good CPA or EA.  It may be better to get it corrected before the tax year you sell the property or it may not matter much.

Good luck

[Sibley]

Technically, you are correct. However, 20 years in, I don't really think its worth the hassle until they sell it. Everything is setup in the software (slightly wrong), so it flows pretty smoothly. The IRS clearly hasn't noticed, or if they have, they don't care. They'll just pay more tax when they sell the house, and house proceeds will cover the taxes. I'll probably get all the numbers organized and dump the whole problem on a tax accountant that year.