Depreciation and capital gains

Tax Talk

Discussing the AMT and how to deduct mortgage interest expenses in a divorce's tax experts answer your questions this filing season

March 10, 2004|By Todd Beamon | Todd Beamon, Staff

Each Wednesday through April 21,'s tax experts will answer your questions this tax-filing season.

Our experts are Jim Dupree of the Maryland office of the Internal Revenue Service in Baltimore and, this week, Nicole M. Harrell, head of her own accounting firm in Baltimore.

To be included next week, please use the form at the right side of this page to submit your questions.

I sold my home, my primary residence, in 2003 and qualified to ignore the gain on the sale for tax purposes. However, I need to record the depreciation I took on the house after May 6, 1997, and report it as a gain. How do I determine how much depreciation to report for 1997?

Will, Perry Hall

Dupree: Here is the short, and fairly simple, answer: Since you claimed whatever depreciation you took for the tax year 1997, in the year 1998, all the depreciation allowed for 1997 was claimed after May 6, 1997.

Also, the way you report the gain depends on a couple of factors not evident here, including: Was the depreciation taken on a part of the home used for business or rental, or was it taken on a separate part of the property used for business or rental? Let's assume the former. Here is a good example:

Ray sold his main home in 2003 at a $30,000 gain. He meets the ownership and use tests to exclude the gain from his income. However, he used part of the home as a business office in 2002 and claimed $500 in depreciation.

Because the business office was part of his home -- not separate from it -- he does not have to allocate the basis and amount realized between the business part of the property and the part used as a home. In addition, he does not have to report any part of the gain on Internal Revenue Service Form 4797. He reports his gain, exclusion and taxable gain of $500 on Schedule D, or Form 1040.

This, and other examples, is contained in IRS Publication 523, "Selling Your Home."

Harrell: You are correct in that the gain you realized on the sale of your primary residence may be excluded from income taxes, but can only be done if you used the home as your primary residence for at least two of the past five years -- ending on the date you sold the residence and only if your gain was less than $250,000 for individuals and $500,000 for married couples filing joint returns.

If you use the property for business or as rental property, you must include the portion of the gain equal to the depreciation that you claimed for business use.

Calculating the portion of the gain that should be included as income depends on several factors. You need to consider the length of time you use the property for personal use, as well as which part of the property was used for business or rental income.

If part of the house, or all of the property, was used for business, the depreciation that you have taken should be included as a taxable gain. The entire gain can be excluded if you did not take past depreciation. But if one part of the property was used for business and a separate part for personal -- for instance, you lived in one apartment of an apartment building you owned -- then you must determine the overall cost of the property and then calculate the gain realized on the sale between the business and personal uses.

You may be able to exclude the gain if you can meet the personal-use test described above. In such instances, you must report the sale of the business on Internal Revenue Service Form 4797, "Sales of Business Property."

At what income level, or capital gains amount, do you become eligible for the alternate minimum capital-gains tax (AMT)? How do you determine the rate?

Rick, Baltimore

Dupree: Your question can be answered two ways: If your question is about the new maximum tax rates of 15 percent and 5 percent on certain capital gains, completing the Schedule D (Form 1040) calculates the appropriate tax for you. If you need to figure AMT, use Form 6251. These forms are very complicated, so the best way to fill them out is to use IRS e-file.

Because the answer to your questions also depends on a number of other variables, especially this year with qualified and nonqualified dividends, the best way is to file electronically using tax software -- and let the software do the work for you.

However, if you insist on preparing a paper return, you can get Form 6251, "Alternative Minimum Tax - Individuals," and the instructions for Form 6251 at our Web site at or by calling 800-829-3676.

Harrell: The AMT applies to taxpayers who have certain types of income that require special tax treatment or who qualify for certain special deductions. Some taxpayers with substantial income can reduce their regular taxes significantly if they qualify for special deductions -- for instance, having a large number of itemized deductions.

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