Decreasing the amount of gain recognized on the sale of a residence used partially for business.

• Author: Ellentuck, Albert B.

Facts

Chuck purchased a home in 1982 for $125,000. In June 1994, he sold the house for $155,000. The selling expenses were $10,000.

Chuck is a self-employed sales representative and used part of his home as an office. Because the office was his principal place of business and was used exclusively for business on a regular basis, Chuck has properly claimed a home office deduction for several years. The office occupied 10% of the total space in the home, and Chuck had claimed $2,500 of depreciation.

Issues

Is it possible for Chuck to defer the entire gain, even though a portion of the home was used as an office? If not, how much must Chuck reinvest to defer gain on the portion not used for business?

Analysis

A taxpayer must defer the gain from the sale of a principal residence to the extent he makes a qualified reinvestment. Although the determination of whether a home is a principal residence is based on facts and circumstances, the use of a part of the home for business purposes will disqualify that part from the gain rollover provisions. Thus, if Chuck is entitled to a home office deduction for 1994, he will not be able to defer the gain allocable to the part of the house used as his office.

To determine the taxable portion of gain, the sales proceeds must be allocated between the portion of the property used for personal purposes and the portion used for business. The amount realized on the sale is $145,000 ($155,000 sales price -- $10,000 selling expenses). This amount is allocated between the business ($14,500) and personal ($130,500) portions of the residence, based on the percentage of use for each purpose. Thus, the realized gain attributable to the office is $4,500 ($14,500 proceeds -- $10,000 adjusted basis ($12,500 of purchase price reduced by $2,500 depreciation)), while the realized gain attributable to the residence portion is $18,000 ($130,500 -- $112,500 of adjusted sales price).

The portion of the gain allocable to the office cannot be deferred by purchasing a replacement property. Chuck must recognize the $4,500 gain attributable to the business portion of the home.

Chuck can defer the $18,000 gain attributable to the personal...