Exclusion from Tax of Gain on the Sale of a Home Used Partly for Business

Generally, when you sell your main home you can exclude from federal income tax any gain on the sale up to $250,000 or up to $500,000 if you are married filing jointly. To qualify for this exclusion you must have owned and lived in the property as your main home for at least 2 years during the 5 years prior to the sale. Also, you must not have excluded the gain on the sale of another main home in the last two years.

If you sell your home at a gain and qualify to exclude the entire gain, you do not have to report the sale on your federal income tax return. If your gain is more than the exclusion amount, you would report the sale on Form 8949, which is a new form for 2011. You would pay long-term capital gains tax on the difference.

A loss on the sale of your home is not deductible. But if you receive a Form 1099-S for the sale, you would have to report the sale on Form 8949, even though the loss is not deductible.

According to the IRS, if you rented out your main home part of the time, you can still exclude the gain on the sale provided you meet the ownership and use test. The two years do not have to be continuous. For example, if during the last five years you lived in the home for one year, rented it out for three years, and then returned and lived in the home for one year, you would qualify to exclude the gain.

You generally cannot exclude the part of the gain that corresponds to nonqualified use of the property in 2009 or later. This would be any period when you did not use the property as your main home. There are exceptions for temporary absences and for military and intelligence community service. The amount of the gain that does not qualify to be excluded would be in proportion to the number of days you did not use the property as your main home in 2009 and later compared to the total period of ownership.

If you rented out your home, you could not exclude the part of the gain that corresponds to depreciation you claimed or could have claimed during the period you rented your home after May 6, 1997. If your home was a rental property at the time you sold it, you would report the sale on Form 4797, Sales of Business Property. If you qualify, you can still exclude the gain except for the depreciation.

If you were living in the home at the time you sold it, after having previously rented your home, you would report the sale on Form 8949, which is a new form for 2011. The results on Form 8949 are carried over to Schedule D.

The depreciation recapture would also apply if you used your home partly for business, such as if you claimed a tax deduction for a home office. You could not exclude the part of the gain that corresponds to depreciation after May 6, 1997. But according to the IRS, you do not need to allocate the gain between the part of the property you used for business purposes and the part you used as your home. And you do not have to report the sale on Form 4797.

If you have a property with a separate part that you use exclusively for business, such as could be the case with a farm, a duplex, or a business with a separate apartment, you could not exclude any gain on the part of the property used for business. You would have to allocate the basis of the property and the amount you realized on the sale between the business part and the part you used as your home. The gain or loss on the business part of the property would be reported on Form 4797.

If you converted part of your property to business use, but you lived in that part of the home for at least two years out of the five years before the sale, you qualify to exclude the gain on the business portion. For example, if you converted part of your home into an apartment that you rent out, but you previously lived in that part of the home, you would qualify for the exclusion.

But in this case you would have to treat the sale as the sale of two separate properties for tax purposes. You would allocate the basis and the amount realized on the sale between the business and home portions to determine the gain on each portion. The exclusion of gain for the business part would have to be reduced by the depreciation allowed or allowable after May 6, 1997.

If the business portion was being used for rental or business purposes in the year of sale, that portion of the gain would be reported on Form 4797. This would be the case, for example, if you were renting out a separate apartment in your home. If you can exclude all the gain on the home portion you would not have to report it.

If you were using the entire property as your home in the year of sale, you would not have to treat the sale as sales of two separate properties and would not have to file Form 4797. For example, you converted the apartment back to personal use as part of your home. You would report the gain on the sale, and the exclusion, on Form 8949. The depreciation you claimed while you were using a portion of your home for business (renting an apartment) would be recaptured on Schedule D.

In IRS Publication 523, Selling Your Home, you can find worksheets and examples to help you with the calculations to determine your gain on the sale of your home and the amount you can exclude.

Sources:

Form 4797, Sales of Business Property, IRS

Form 8949, Sales and Other Dispositions of Capital Assets, IRS

Instructions for Form 4797, IRS

Instructions for Schedule D (and Form 8949), IRS