Overview
Corporations

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Income Tax When You Sell a Home Used Partly for Business or Rent

When You Rent Out Your Home

When you have rented out your main home for a period of time and you subsequently sell it, you can still exclude all or part of the gain provided you meet the ownership and use tests. In order to meet these tests you must have owned the home for at least two years and lived in the home as your main home for at least two years of the last five years. You could normally exclude the gain up to $250,000, or up to $500,000 if you are married filing jointly. But the depreciation you claimed or could have claimed for the period you rented out your home has to be included in your taxable income and cannot be excluded. In general, if you used your home partly for business or as rental property, the depreciation that was allowed or allowable for the period after May 6, 1997 cannot be excluded.

Home Used Partly for Business or Rental

When you have a property that you use partly as your home and partly for business or rental purposes and you sell the property, the treatment of the gain on the sale will depend partly on whether the business or rental portion of the property was part of your home or separate from your home. For example, you may have a room in your home that you use as an office or workshop, or you may rent out a room in your house. This would be considered a business or rental use within your home. On the other hand, you may have a separate structure on your property that you use for business, such as a garage or barn.

Allocation of Basis and Amount Realized

In some cases it may be necessary to allocate the basis of the property and the amount realized on the sale between the part you use as your home and the part used for business or rental purposes. You will then be able to determine the amount of gain on each part. Provided you meet the ownership and use tests, you can exclude the portion of the gain that corresponds to your home, and you would report the portion of the gain that corresponds to the business or rental part on Form 4797, Sales of Business Property.

Business or Rental Part Within Your Home

Business or Rental Part Within Your Home If the business or rental part is within your home, such as a room you use for a home office, you will not need to allocate your basis and the amount realized on the sale. And you will not need to file Form 4797 for the portion of the sale corresponding to the business or rental part. But you will need to include any depreciation you have claimed or could have claimed as a deduction on the business or rental part after May 6, 1997 in your taxable income.

You meet the ownership and use tests, so you can exclude the gain on the sale. Since your home office was inside your home, and not separate from it, you do not need to allocate the basis and the amount realized on the sale between the personal and business portions of your property. But you cannot exclude the part of the gain equivalent to the $2,000 of depreciation deductions you have claimed. You would report the entire gain of $120,000 on Schedule D. Your exclusion would be $118,000, and you would report $2,000 as a taxable gain.

Business or Rental Part Separate from Home

If you have a property where the business or rental part is separate from the part you use as a home, you may have to allocate the basis and the amount realized on the sale. You would have to make this allocation if you did not meet the use test, that is, you did not use the business or rental part as your main home for at least 2 of the last 5 years. Some examples of these separate uses of your property include a farm on which your home is located, or an apartment building in which you live in one apartment and rent out the others.

When You Do Not Meet the Use Test for the Business or Rental Part

In order to qualify for the exclusion of gain on the sale of your home, you have to meet both the ownership and use tests. If you do not use a portion of your property as your main home, you do not meet the use test for that part of the property and therefore cannot exclude a gain on the sale. If you sell the whole property, you will have to allocate the basis and the amount realized on the sale between the part you used as your home and the part you used for business or rental purposes.

For example:

You bought a property that has a house and a barn.
You lived in the house as your main home for three years and used the barn for your business.
You sell the property at a gain

You would have to allocate the basis and the amount realized on the sale of the property between the house and the barn. The gain applicable to the barn would have to be reported on Form 4797. You could exclude the gain on the house (up to $250,000 or $500,000).

If in the above example, you lived in your home for at least 2 of the last 5 years, and you also rented it out for a period of time, but continued to use the barn for business, you would still allocate the basis and amount realized on the sale to determine how much of the gain corresponds to the barn. But you would also have to include in your income the part of the gain that corresponds to depreciation deductions you claimed on the house while you were renting it out.

When You Meet the Use Test for the Business or Rental Part

If you have property, part of which is used as a home and part has been used for business or rental purposes, and you have met the use test for the business or rental part (you used it as your home for at least 2 of the last 5 years), how you treat the gain on the sale of the property depends on how you were using the business or rental part in the year of the sale.

UUsed for Business or Rental in Year of Sale

If you were actually using it for business or rental purposes the year you sell the property, you will have to treat the sale as two separate sales, one for the business or rental part and one for the part you presently use as your home. In this case, you would have to divide the selling price, selling expenses, and the basis in the entire property between the part used for business or rental purposes, and the part used as your home. Then, you would also have to allocate your exclusion amount between the two parts.

Generally you can exclude the gain on the business or rental part if you have met the ownership and use tests for exclusion of gain. You would report the sale of the business or rental part of the property on Form 4797 and would claim the allocated part of your maximum exclusion on that form. If you have depreciation allowed or allowable after May 6, 1997 on the business or rental portion, you will need to fill out the “Unrecaptured Section 1250 Gain Worksheet” in the Schedule D instructions, and then use the “Schedule D Tax Worksheet” to figure your tax.