In regards to how to treat the sale of your home if a portion of it is used for rental, that depends on whether that portion of the property is still being used for business or rental leading up to the sale.
What if the space was formerly used for rental, but was not rented during the year of sale?
Space that was once used for business or rental purposes can be considered a residence space at the time of sale. A space formerly used for business is considered residence space if ALL of the following are true:
- You weren’t using the space for business or rental at the time you sold the property,
- You didn’t earn any business or rental income from the space in the year you sold your home, and
- You used the space as residence space for 2 years out of the 5 years leading up to the sale.
If you meet those requirements at the time of sale, then you would simply report the sale as the sale of your primary residence, gain would be able to be excluded however you are still required to recapture any allowable depreciation as "ordinary income."
You will need to complete the Sale of Main Home Worksheet on your return. Make sure you have your previous year’s records so that you can appropriately complete the sections regarding the recapture of allowable depreciation. Go to:
- Income (select my forms)
- Sale of Main Home Worksheet
What if I don’t meet the qualifications to treat the rental portion as my residence?
If you have used part of the home (not within the home’s living area) for solely business or rental purposes for more than 3 of the last 5 years, you need to make separate gain or loss calculations for the business and residence portions of your property. More information on exactly how to calculate this, and what different methods can be used, can be found in IRS Publication 523. To simplify it though, you essentially treat your rental portion of the home as a separate sale of property than your personal residential portion.
The sale of the residential portion would be done as the sale of your main home (if you meet the criteria for excluding gain in the year that you sell it, which is to have lived in and owned for at least 2 of the last 5 years, you can claim the exclusion). Follow the steps above to complete the Sale of Main Home Worksheet. Your cost basis and proceeds need to be prorated based on the total square footage of the home that was not used for business or rental.
The sale of the rental portion would be reported on form 4797 for the sale of a business property. Allowable depreciation will be recaptured on this form. The cost basis that you use to depreciate the rental portion would be listed as your "cost basis" on form 4797, and that amount should be subtracted from the "cost basis" of the sale of your main home. Likewise, you should use the same percentage to figure how much of the gain is related to the "business" portion and allocate the gain appropriately.
How do I report the sale as Business Property on Form 4797?
To find Form 4797 go to:
- Income (select my forms)
- Less Common Income
- Sale of Business Property Form 4797