Assuming you have met the ownership and use tests for the entire property (home and business or rental portions) and you were not actually using the business portion of your property for business in the year of sale, but rather were using it as part of your home, you would not have to treat the transaction as the sale of two separate properties. You would not have to file Form 4797 and could generally exclude the entire gain if it is not more than the maximum allowable exclusion.
Example – No Business Use in Year of Sale
Assume the same facts as in the previous example, except that your business grows to the point where you have to move out of the basement level of your home into a separate property. You return to using the basement level as part of your home. That year you sell the property, based on the same terms as previously indicated.
You would report the entire gain of $64,000 ($40,000 plus $24,000), and your allowable exclusion of $60,000 ($40,000 plus $20,000) on Part II of Schedule D.
Your taxable gain of $4,000 is due to depreciation claimed when the property was being used for business (after May 6, 1997). This is unrecognized section 1250 gain, so you would have to enter it in the Unrecaptured Section 1250 Gain Worksheet in the Schedule D instructions.
If you had no other unrecaptured amounts to report, this amount would go on Schedule D, and you would figure your tax using the Schedule D Tax Worksheet.