How to Calculate Adjustment Amount on Form 8949 When Proceeds Exceed Cost Basis

Thanks for the response! So if I claimed about $22,000 in depreciation over the 2 years it was a rental, would I need to somehow reflect that? Do I reduce my cost basis by that amount or put something in column g? Sorry for the basic questions, just want to make sure I'm doing this right.

Yes, depreciation is exactly what's likely causing the issue! When you claimed depreciation during the rental period, you need to reduce your cost basis by that amount. So if your original cost basis was $400,000 and you claimed $22,000 in depreciation, your adjusted cost basis would be $378,000. For Form 8949, you would then put $528,000 in column d (proceeds), $378,000 in column e (adjusted cost basis), and column g would remain 0 since no further adjustments are needed. The gain would be $150,000 ($528,000 - $378,000). That depreciation recapture is why your gain is higher than you initially calculated.

Does it actually explain WHY something is wrong or just flag potential issues? I've tried tax software that just gives generic warnings without really explaining the underlying problem.

Hmm, sounds interesting but how does it handle more complex situations? I sold a property that was partially used for business and had significant improvements plus some casualty loss recovery. Would it understand all those basis adjustments?

It actually provides explanations for why something appears incorrect, including citations to the relevant tax rules or IRS publications. It's not just generic flags - it explains concepts like depreciation recapture and basis adjustments in plain language. For complex situations with multiple types of adjustments, it handles those really well. The system can identify various components affecting your basis including business use percentage, improvement costs, casualty losses, and insurance recoveries. It breaks down how each factor affects your final numbers and provides a detailed explanation of how to correctly report everything.

Wait, how does this actually work? Do they have some special access to the IRS or something? Seems fishy that they could somehow get through when regular people can't.

Yeah right. I've tried EVERYTHING to get through to the IRS during tax season. There's absolutely no way this actually works. The IRS phone system is designed to be impossible. What's the catch here? Do they charge an arm and a leg for this "service"?

There's no special access - they use an automated system that does the waiting for you. Basically, they call the IRS and navigate the phone tree, then hold your spot in the queue. When they detect they're about to reach an agent, they call you and connect the calls. You're speaking directly with the IRS, not through an intermediary. The technology is pretty straightforward - it's just automated dialing and call monitoring that recognizes when a human answers. There's nothing fishy about it - they're just doing the waiting part for you so you don't have to sit on hold for hours. I was skeptical too, but it worked exactly as advertised.

How does this work if the property qualifies for partial Section 121 exclusion? Do you still adjust the basis the same way or does that go in column g?

If your property qualifies for a partial Section 121 exclusion (primary residence exclusion), that's actually one of the cases where you might use column g. Since you lived in the property for 3 years out of the 5-year period before selling, you likely qualify for at least a partial exclusion. In this case, you would still reduce your cost basis in column e to account for depreciation taken. Then, you would use column g to report the Section 121 exclusion amount as a negative number (reducing your gain). The code to use would be "H" for "Section 121 exclusion." You'd include an explanation that you're claiming a partial exclusion based on meeting the ownership and use tests for a portion of the 5-year period.

For depreciation recapture on a rental property, you typically won't need a specific adjustment code in column f. The depreciation should already be factored into your adjusted cost basis in column e. If you're using column g for other adjustments (like Section 121 exclusion), you'd use code "H" for those. But for straightforward depreciation recapture, you just report your reduced basis and don't need a special code.

This is exactly the kind of detailed explanation I was looking for! I had no idea that depreciation recapture goes on Form 4797 instead of Form 8949. That completely explains why TurboTax kept flagging my entries - I was trying to handle everything on the wrong form. So just to make sure I understand: I report the capital gain portion on Form 8949 using the depreciation-adjusted basis of $378,000, and then separately report the $22,000 depreciation recapture on Form 4797 at ordinary income rates. And since I lived there for 3 years as primary residence, I should definitely look into the Section 121 exclusion too. Thank you for breaking this down so clearly! This has been driving me crazy for days.

This is incredibly helpful! I've been struggling with a similar situation where I converted my primary residence to a rental. One quick question though - if the property qualifies for partial Section 121 exclusion, does that exclusion apply to both the capital gain portion AND the depreciation recapture, or just the capital gain? I want to make sure I'm not missing out on any tax benefits I'm entitled to. Also, for anyone else dealing with this - make sure you have good records of all the improvements you made to the property over the years, as those can be added to your cost basis and reduce your overall gain.

Great question about the Section 121 exclusion! The exclusion typically only applies to the capital gain portion, NOT to the depreciation recapture. The IRS treats depreciation recapture as "unrecaptured Section 1250 gain" which is taxed at up to 25% and doesn't qualify for the Section 121 exclusion. So in your case, if you qualify for the full $250,000 exclusion (or $500,000 if married filing jointly), it would apply to the capital gain after accounting for depreciation recapture. Your $22,000 depreciation recapture would still be taxable, but depending on your total gain, you might be able to exclude a significant portion of the remaining capital gain. And absolutely agree on keeping good records of improvements! Those additions to basis can make a huge difference in your final tax liability.

Thanks Paolo for sharing your real experience! This is exactly the kind of practical insight that helps make sense of what seemed like an impossible puzzle. I'm in almost the exact same boat - primary residence for 3 years, rental for 2 years, and I was definitely making the same mistake of trying to cram everything into Form 8949. Your breakdown of having three separate forms involved (4797 for depreciation recapture, 8949 for capital gain, and 1040 for Section 121 exclusion) really clarifies the whole process. I had no idea these were treated as fundamentally different types of income - that explains why my calculations kept coming out wrong when I tried to handle it all in one place. Question about the improvements though - do these need to be capital improvements specifically, or can regular maintenance and repairs count toward basis? I replaced the water heater and did some plumbing work, but I'm not sure if those qualify as basis-increasing improvements.

Great question about improvements vs. repairs! The IRS distinguishes between capital improvements (which add to your basis) and regular maintenance/repairs (which don't). For your water heater replacement, that would typically qualify as a capital improvement since you're replacing a major system component with something that extends the property's useful life. The plumbing work could go either way - if it was fixing existing problems, that's maintenance. But if you upgraded the plumbing system or added new fixtures, that would likely be a capital improvement. The key test is whether the work adds value, prolongs the property's life, or adapts it for new uses. Repairs just restore something to its previous condition. When in doubt, keep the receipts and documentation - you can always consult a tax professional for the specific items. I actually missed claiming several legitimate improvements on my first attempt because I thought they were just repairs. A new roof, upgraded electrical panel, and kitchen renovation all counted toward basis and saved me quite a bit in taxes.

Hannah, this breakdown is incredibly helpful! I've been struggling with this exact same issue and your step-by-step approach makes it so much clearer. I was definitely trying to force everything through Form 8949 and getting frustrated when the numbers wouldn't work. One thing I'm still confused about - when you say "partial Section 121 exclusion" for someone who lived in the property for 3 years, how do you calculate what portion of the exclusion you're eligible for? Is it simply 3/5 of the full $250,000 exclusion, or is there a more complex calculation involved? Also, I appreciate you mentioning the improvements again. I think I've been too conservative about what counts as a capital improvement. Sounds like I should review all my major expenses over the ownership period and see what might qualify to increase my basis.

@c6c4ccd37dc1 This is exactly what I needed to see! Your step-by-step breakdown finally makes sense of why I was getting error messages. I was definitely trying to jam everything into Form 8949 when the depreciation recapture belongs on Form 4797. Just to clarify on the Section 121 exclusion calculation - since I lived in the property as my primary residence for 3 out of the last 5 years before the sale, I should qualify for the full exclusion amount, not a partial one, right? The "partial" aspect would only apply to the fact that some of the gain (the depreciation recapture) isn't eligible for exclusion at all. Also, regarding improvements - I'm realizing I probably have more qualifying expenses than I initially thought. New HVAC system, roof replacement, and kitchen renovation over the years should all count toward increasing my basis. Time to dig through those old receipts! Thanks for breaking this down so clearly. Finally feel like I can get this filed correctly.