Discussion:Tax benefit rule/depreciation recapture

YES, it does, therefore NO you can't use the tax benefit rule

The answer to your question - a very good question - will depend on which of these is the case. And here's a kicker: *both* of them might apply.

Stay tuned while Kevin starts backpedaling...

In general, the gain you cannot treat as tax free is equal to the applicable depreciation after 1997. This would be Sch D capital gain, not taxed as ordinary income and no recapture of any SE tax you saved from the deduction.

Any carryover office in home deductions may be allowed in the year of disposition.

If the home office is a totally separate structure from the residence, you must still allocate this as a sale of two separate properties.

Here's a quote from Pub 587, in the chapter "Sale or Exchange of Your Home" that has puzzled me:

"Depreciation - If you were entitled to deduct depreciation on the part of your home used for business, you cannot exclude the part of the gain equal to any depreciation you deducted (or could have deducted) for periods after May 6, 1997. This means that when figuring the amount of gain you can exclude, you must reduce the total gain by any depreciation allowed or allowable on the part of your home used for business after May 6, 1997.

If you can show by adequate records or other evidence that the depreciation you actually deducted (the allowed depreciation) was less than the amount you were entitled to deduct (the allowable depreciation), the amount you cannot exclude (and must subtract from your total gain when figuring your exclusion) is the amount you actually deducted."

Any thoughts?

(2) Did the taxpayer "derive no benefit" (in those modest income years) because he wasn't allowed to deduct some or all of the depreciation on his home office because of the statutory limits (see IRC Section 280A(c)(5)) on home office deductions?

The exception to allowed or allowable is in the Code. All you CodeHeads here should know about it.

In that sense it stands to reason that you would eliminate any depreciation where there was no benefit, since its inclusion would increase the current year 280A deduction, and reduce SE tax in a Sch C situation.

"...it stands to reason that you would eliminate any depreciation where there was no benefit..."

"It stands to reason..."??!?? You forget so easily: we are dealing with the Tax Code here. "Reason" is nowhere to be found.

According to Code Section 121(d)(6) "Recognition of gain attributable to depreciation - Subsection (a) shall not apply to so much of the gain from the sale of any property as does not exceed the portion of the depreciation adjustments (as defined in section 1250(b)(3)) attributable to periods after May 6, 1997, in respect of such property."

You should read the definition of "depreciation adjustments" in Code Section 1250(b)(3). Your mouth will drop open.

And for once, a publication actually considers Section 59(g). Well, make it twice since Pub 525 does likewise.

And those who do Pennsylvania returns are familiar with this concept when there are sales of rental properties where depeciation provided no tax benefit.

There is no unrecaptured 1250 gain on sale of an office situated in a home. Depreciation was S/L over 39 years and there would be zero of that.

The IRC says to the extent depreciation was deducted for that office in home, that amount of the gain on sale is not excluded under 121. If gain was less, your recapture is limited to the amount of the gain. Sch D Entry for that amount of the gain and taxed like any other capital gain. No entry to unrecaptured 1250 gain. If you sold at a loss - no recapture and no loss allowed.

If there was no tax benefit from the depreciation deduction because the business sustained a net loss and the home office deduction was thereby limited, then in my opinion the depreciation was not, in fact, taken as a deduction.

280A(c)(5) has an ordering scheme that specifies certain deductions allocable to the business use of a home to be deducted first, and depreciation is the last item to be allowed. So, if the depreciation is not allowed due to this limitation, then it is not that there was "no tax benefit" for the deduction, but rather, that there was no deduction.

I stand corrected - The amount of the gain is entered as a long term capital gain on Sch D and the same amount goes into the tax calculation on Sch D as unrecaptured 1250 gain.

Reminds me of that foil wrap my mother would call 'Reynolds wrap' while my father said 'aluminum foil' and sometimes say 'aluminium' just to make a joke. Pam calls it 'aluminum foil too, but I hark back to the phrase Morgan, my late wife, used for the 26+ years we were married: 'Silver paper.' Such nice words, and so descriptive, and whether I ask Pam to get me the 'silver paper' or she asks me to hand her the 'aluminum foil,' we end up with the same thing in our hands.

Has anybody read IRC Section 1250(b)(3) yet? Whadja think of the last sentence in the paragraph? It's an eye-opener.

For so long we were told 'take the depreciation because IRS considers it allowed or allowable and you will have to give it back when you sell whether you deducted it or not.' Then several years ago IRS made it easier to correct for the missing deduction, allowing us to catch up on accumulated depreciation all at once. Understand I am talking about a business 1250 property, not a home office. The point is that the depreciation in such situation can never be lost, (except perhaps through death)......such depreciation would be taken when the property is sold [passive loss].

So is that sentence ever relevant except in the case of 121/280A?

If the taxpayer can show that he never claimed the home office depreciation, the basis in his property will go down (allowable) but the gain [= the depreciation taken] *isn't* subject to being *not* excluded under the Section 121 rule. It's hard to put in words. Here's what IRS says, quoted from above: "If you can show by adequate records or other evidence that the depreciation you actually deducted (the allowed depreciation) was less than the amount you were entitled to deduct (the allowable depreciation), the amount you cannot exclude (and must subtract from your total gain when figuring your exclusion) is the amount you actually deducted."

Absolutely! It avoids ordinary income treatment of what would otherwise be Section 1250 recapture under the usual "allowed or allowable" rules when the taxpayer can show he didn't take the depreciation. He may still pay the capital gain but he avoids the recapture taxed at ordinary rates. Anybody who was doing taxes in the 70s should know this. If you don't, you may have screwed clients who were selling depreciated real estate back then.

It doesn't avoid the income, it avoids the *ordinary* tax rates being applied to the "recaptured depreciation" income.

But there's effectively *no* Section 1250 recapture these days because of other changes in the tax laws. Oh it was so simple back then... Hah!!!!

1250 unrecaptured gain is a subset of capital gain

or maybe I'm missing your point completely

Yes, I wrote *recaptured* not *unrecaptured*. One of my whines earlier in this thread was that if we don't distinguish between these two words, we don't know what we're doing. Remember the snide remark I made about Kleenex? Maybe I wasn't as blunt about it then...

And I woulda thunk that *unrecaptured* section 1250 gain would be a subset of Section 1231 gain... It does get "offset" [hate that word, too] against Section 1231 losses, doesn't it? Like on Form 4797 [that's in the usual case; I understand Schedule D might be where the special case unexcludible home office gain would be reported.]

But, Harry, not to get off the subject, but do you know when Section 1250 property is taxed on sale as section 1245? Answer: Commercial property depreciated under ACRS is still taxed as 1245 property when sold! Where I worked, we used straight line from 1981-86 on any commerical property. Discussion: Depreciation recapture on 15 year commercial building (ACRS, 3-1-84)