Q. I recently sold my home, which was used 90 percent for my business and the remainder as my principal residence. Over the years, I have depreciated the business portion (but, of course, not the land). Since I am well over 55, am I entitled to any part of the $125,000 exclusion? I figure I should be permitted to claim 10 percent, or $12,500. I will appreciate your comments.
A. It doesn't work quite that way. You actually are entitled to the full $125,000 exclusion -- but it may be applied only against that portion of the gain that represents profit on your personal residence.
You have to report the sale in two parts, as if it were two separate sales. On Form 2119 (Sale or Exchange of a Principal Residence), you report 10 percent of the total transaction.
That is, you enter 10 percent of the sales price, 10 percent of any real-estate agent's commission and other selling expenses, and then the basis for that part of the house that was used as your residence.
That last number may be a little tricky. You start with 10 percent of the original cost, including the land; then add 10 percent of any permanent improvements that affected the entire structure; and finally you may add the entire cost of any improvements that were made only to the residence part of the building.
When you arrive at the gain on the sale of the residential portion, you may then exclude the entire amount, up to the $125,000 ceiling. You do that by completing Part III of Form 2119 and attaching it to your tax return.
The other part of the transaction -- the sale of the 90 percent of your home that had been used for business -- is reported on Form 4797 (Supplemental Schedule of Gains and Losses). Here you take into account 90 percent of the original cost and of whole-house improvements plus 100 percent of any improvements made only to the business structure.
You must then reduce the cost basis by all of the depreciation taken over the years on the business property. As you can see, this permits you to retain as part of the basis the entire land cost and any business improvements not yet fully depreciated.
There are other parts of Form 4797 that may have to be completed, but they are not germane to this discussion. I have given you only the bare bones of the rules covering your situation. I think this answers your immediate questions, but I suggest you get some professional help in the preparation of what is likely to be a fairly complex tax return.
Q. I am puzzled by the instructions for IRS Form 4972, Special 10-Year Averaging. Instruction D says that after age 59 1/2, 10-year averaging can be chosen for only one distribution. I am just turning 60 and contemplating early retirement. I qualify for and plan to take my company retirement in a lump sum, about 85 percent of which would be eligible for 10-year averaging or rollover into an IRA. But I also participate in my company's savings plan and have accumulated considerable untaxed growth through reinvested earnings and company matching. What are my options? The most favorable tax approach would be to take each distribution as a separate lump sum. If that's not possible, can the two distributions be lumped for 10-year averaging? Other than IRA rollover, are there any other desirable options?
A. Long question, short answer: After age 59 1/2, 10-year averaging for lump-sum distributions may be selected only for one year. And you may not report each distribution on a separate Form 4972 -- which would, of course, result in a lower tax. You should add together all distributions from the various qualifying retirement plans of your employer, then apply the special averaging technique to the total.
If any part of the lump-sum distribution is attributable to years prior to 1974, that part may be treated as capital-gain income and reported on Schedule D, with the balance accorded 10-year averaging. Capital gains, rollover to an IRA and 10-year averaging are really the only tax-favored options for a lump-sum distribution. You could, of course, report the entire distribution as ordinary income and use regular income averaging on Schedule G, but normally that will be the least favorable method.