Allocating Gains of Part-Business Property

For depreciable property that is used for both business and personal purposes, both the basis and sale proceeds of the property must be allocated between the two types of usage.

Essentially, the property will be treated as if it were two separate pieces of property. This applies to both real estate (e.g., your home office), and to property like cars, computers, office furniture, and equipment.

As a general rule, the taxable gain or loss on the business portion's disposition will be reported on Form 4797, Sale of Business Property.

In contrast, any gain or loss on the personal portion will be reported on Schedule D of your individual income tax return. Note that any losses on the personal portion of the home or equipment are not deductible, although gains on this portion may be taxable.

In the case of a home office, a special provision in the law says that up to $250,000 in capital gains (or $500,000 on a joint return) will be excluded upon sale of the home, if the home has been used as a principal place of residence for two out of the last five years before the sale. If you have been using part of your house as a home office or for a business use, then you do not need to allocate gain on the sale of the property between the business part of the property and the part used as a home. This means that you don't need to file a Form 4797. This is true whether or not you were entitled to claim any depreciation. However, you cannot exclude the part of any gain equal to any depreciation allowed or allowable after May 6, 1997.

However, if you used a separate part of your property - not your home itself, but an outbuilding or detached garage - for business, you cannot exclude gain on the separate part of your property used for business unless you owned and lived in that part of your property for at least 2 years during the 5-year period ending on the date of the sale. If you do not meet the use test for the business part of the property, or if you used that portion of the property for business in the year of sale, you must make an allocation of the gain on the sale is required. For this purpose, you must allocate the basis of the property and the amount realized upon its sale between the business part and the part used as a home. You must report the sale of the business part on Form 4797.

For more information, see our case study showing the effects of a sale of a home office.

© 2024 Wolters Kluwer. All Rights Reserved.