If you've bought or sold a property that was used for business purposes within the last year, you're going to need to fill out IRS Form 4797 in addition to your regular tax return. With that in mind, below is a closer look at this form, what you should know when filling it out, and how it differs from a Schedule D. Read on below to learn what you need to know about this form before submitting it to the IRS.
What is IRS Form 4797?
Form 4797 is a tax form to be filled out with the Internal Revenue Service (IRS) for any gains from the sale or transfer of property that was used for business purposes. This can include but is not limited to any property that was used to generate rental income or a home that was used as a business.
Additionally, IRS Form 4797 is used to report gains from the sale of property that was used for industrial, agricultural, or extractive services. Gains from the sale of properties that are used for oil, gas, geothermal, or mineral purposes should also be included on this form. Lastly, this form should also be used if your business was subject to involuntary conversion or recapture.
Notably, though, if you happen to work from home and you're selling your primary residence, you likely will not need to fill out this form. In that case, any gains from the sale of your primary residence would be deemed eligible for the capital gains tax exclusion. This is mainly used to report gains from the sale of real estate that was strictly used as business property.
What are the differences between Schedule D and Form 4797?
Often, when people go to fill out their tax return for the prior tax year and they've sold real property, they wonder whether they should fill out a Schedule D or a Form 4797. While these two items both have to deal with reporting gains, there's a significant difference between them. Generally, a Schedule D is used to report personal gains, while Form 4797 is used to report gains from the sale of property that had a business use.
In the event that the same real property asset was used for both business and personal purposes, you must allocate any realized gains between the two forms.
Using Schedule D and Form 4797: A Practical Example
Let's say, for the purposes of this example, that the property you sold was a duplex. Before selling, you used one unit as your primary residence and rented the other unit out to a tenant. You ultimately earned $30,000 worth of profit from the sale of the property.
In this case, since the building has two units, you could split the amount down the middle. A $15,000 gain would be reported on Form 4797 to account for the sale of the rental property. Meanwhile, you could claim a $15,000 exclusion on your Schedule D to account for the sale of your primary residence.
A similar approach would be applied if you're working on a farm where your house is also located or you own a storefront that also has livable apartment space above it.
How to complete Form 4797
You can access a copy of Form 4797 through the IRS website or at the office of a tax preparer. Once you have a copy in hand, start by filling out your name, as shown on your tax return, and your taxpayer identification number. For individuals, this would be your social security number, and for those whose business is registered as a corporation, it would be your EIN number.
On Line 1, you should report any proceeds from sales or exchanges that have been reported on a 1099.
Part 1, Line 2 is where you record any business property that was purchased or sold and held for more than a period of one year. You need to include each property that was bought or sold, the dates of purchase or sale, the gross sale price, any depreciation, the cost of improvements, and the total gain or loss you've experienced.
Add each amount along with any other amounts specified in the following lines:
- Line 3: Any gain listed on Form 4684, line 42.
- Line 4: Any Section 1231 gain from an installment sale.
- Line 5: Any Section 1231 gain or Section 1231 loss from like-kind exchanges reported on Form 8824.
- Line 6: Any gains reported on Line 32 of your tax return, except casualty or theft.
On Line 7, report the total amount of gains or losses that you calculated from lines 2-6.
If you have a nonrecaptured Section 1231 loss from any prior year, it should be recorded on Line 8.
Subtract Line 8 from Line 7 and enter the total amount left over on Line 9 to determine your qualified gains or losses.
Filling out Part II is very similar to filling out Part 1, except this time the information should be focused on any ordinary gain or ordinary loss that you received on a property you held for one year or less. Follow the instructions as provided for Lines 11-18 to report the appropriate ordinary gains and losses.
If you have any gains from property sales under Sections 1245, 1250, 1252, 1254, or 1255, those need to be reported on Line 19, along with the date acquired and date sold. Additionally, you'll need to complete the gross sale price, cost basis, depreciation, and total gain for each property in Lines 20-24.
For Lines 25-29, you'll need to fill out the information requested as each property applies to each section of the tax code.
Then in Lines 30-32, add the appropriate lines to get the total applicable gains.
Finally, any recapture amounts must be reported under Part IV, Lines 33-35.
Once that's completed, you can attach Form 4797 to your regular tax return. Though, ideally, you should also retain a copy for your records as well.
The bottom line
Even though there are instructions on Form 4797 that guide you through how to fill it out properly, there can still be confusion that can lead to costly mistakes down the road, particularly since real estate investors and other business professionals typically don't have a wide breadth of tax experience.
With that in mind, this is a good time to seek out the advice of a CPA or other local tax professionals. In particular, you may want to ask if they have experience with real estate taxes and Form 4797 just to ensure you're in good hands.