Tax season always welcomes a flurry of legal documents and financial accounting that can make the most experienced taxpayer’s head spin. While tax season has its unique host of challenges, Real estate has proven to be an invaluable tax shelter for today’s investors. It is thanks to properly crafted tax strategies that good investments can turn into great wealth-building opportunities. While expertise and smart investment tactics will always come in handy, no tax strategy is complete without knowing which forms are required, which information needs to be gathered, and how to file the proper paperwork.
Investors and business owners must know which steps to take if they hope to optimize their profits come tax time, and understanding IRS Form 4797 is no exception. With FortuneBuilders’ helpful guide, real estate investors can learn what IRS Form 4797 is, how to complete Form 4797, as well as what Form 4797 is used for when selling a business. The following article is dedicated to teaching investors what Form 4797 is, how to fill it out, and what implications it may have for their businesses.
What Is Form 4797?
Anyone who has realized gains from the sale or transfer of a property used for business purposes is required to file Form 4797 along with their regular tax return with the IRS for the year the gains were realized. If, for example, a property was put in service to generate cash flow or used as a business and then sold for a profit, the owner realizing the capital gains will be required to file IRS Form 4797 with the IRS. For a brief idea of what information needs to be gathered, this includes but is not limited to:
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Property Description
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Purchase Date
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Sale or Transfer Date
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Purchase Price
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Gross Sales Price
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Depreciation Amount
As one might imagine, Form 4797 is a bit more intensive than a standard tax return, but completion is required to support legal business operations. Especially for real estate investments becoming actualized by a potential sale, it’s in the property taxpayer’s interest to ensure they’re properly squared away with the IRS.
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What Is Form 4797 Used For?
IRS Form 4797 is reserved for reporting gains from the sale of real estate that was used solely for business operations. However, it is worth noting that the property needed to be used as a business (not for a business); that’s an important distinction to make. People who worked from home most likely won’t need to fill out IRS Form 4797 when they sell. In the case of selling the primary residence that you used for business purposes (not as a business itself), the residence could potentially qualify for capital gains tax exclusion. Form 4797 is strictly used to report the sale and gains of business property real estate transactions.
This might include any property used to generate rental income or even a house used as a business but could also extend to property used for agricultural, extractive, or industrial purposes. Capital gains from the sale of business properties used for gas, oil, geothermal, or mineral purposes should also be included with Form 4797. Additionally, Form 4797 would be completed by anyone whose business experienced involuntary conversion or recaptures.
According to the IRS guide, Form 4797 may also be used to report:
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Any involuntary conversions of real estate and capital assets
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The disposition of noncapital assets
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The disposition of capital assets which weren’t included on Schedule D
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The gain or loss for partners and S corporation shareholders from certain section 179 property dispositions by partnerships and S corporations
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The computation of recapture amounts under sections 179 and 280F(b)(2) when the business use of section 179 or listed property decreases to 50% or less
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Gains or losses treated as ordinary gains or losses, if you are a trader in securities or commodities and made a mark-to-market election under Internal Revenue Code section 475(f)
What Is The Difference Between Schedule D & Form 4797?
In the section above, we briefly discussed filling out Schedule D. The differences between Schedule D and Form 4797 are almost negligible to anyone unfamiliar with the IRS tax code but have their unique characteristics. As a result, most people aren’t sure which IRS form they are expected to fill out when they sell a property that was used as a business which can be dangerous when ensuring you’re filing taxes correctly with the IRS and maximizing potential profits made.
Both Schedule D and Form 4797 are intended to acknowledge capital gains; however, that’s where the similarities stop. Whereas Schedule D forms are used to report personal gains, IRS Form 4797 is used to report profits from real estate transactions centered on business use. IRS Form 4797 has much more specific utilization, while Schedule D is a required form for anyone reporting personal gains in general. So when filling out Schedule D, you’ll be automatically referred to Form 4797 if you are reporting gains from the sale of business property.
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How to Complete Form 4797
Filing Form 4797 with the IRS isn’t as complicated as it sounds, nor is it as difficult as many people initially assume. Thankfully, the process is as simple as obtaining a copy of the form through the IRS website; it’s also possible to talk to your local tax preparer for the form to guarantee the form is filled out correctly. Regardless of the way they prefer to handle the tax filing process, those who sell or buy business property will begin by having IRS Form 4797 in hand to include with their tax return.
Start by filling out the generic information on the form: your name, taxpayer identification number (social security number), and anything else to identify who you are. This information will change depending on whether the filer is filing as an individual or a corporation. Once all of the correct personal (or corporate) information has been entered, Line 1 is reserved for any proceeds or exchanges reported on a 1099 form. The rest of Form 4797 will look a lot like the following:
Form 4797 Instructions Part I: Sales or Exchanges of Property
The first section of Form 4749 will cover Line 2 through Line 9 and deals primarily with the subject property’s sale and exchange.
Line 2 is where tax filers will record any properties they purchased or sold and held for longer than a year. There is no need for multiple forms, as Line 2 offers plenty of space to record each property that was bought or sold (and the corresponding information). At this point, filers will need to disclose specific dates of sales and purchase, prices, depreciation (if any), maintenance costs, and the exact amount of capital gains and losses realized in that year.
Sale and purchase amounts will be added to their corresponding lines:
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Line 3: This line is reserved for any gains listed on line 42 of Form 4684 (which refers to any casualties or theft that took place.)
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Line 4: This line will identify any Section 1231 gains from installment sales.
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Line 5: Like-kind exchanges reported on Form 8824 which resulted in either Section 1231 gains or losses will be recorded here.
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Line 6: Any gains reported on Line 32 of the tax return (except those resulting from casualty or theft) will be reported here.
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Line 7: Add up all gains and losses from lines 2-6 and put the amount here.
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Line 8: This line is meant for non-recaptured Section 1231 losses from any previous year.
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Line 9: In the event you had non-recaptured Section 1231 losses, subtract the specific amount from Line 7’s total and put the amount here.
Form 4797 Instructions Part II: Ordinary Gains and Losses
Not unlike Part One, the second section of IRS Form 4797 will require information about the sale and exchange of property in the respective tax filing year. However, unlike Part One, Part Two will only deal with physical real estate owned for less than one year or short-term gains that were realized. The same information from the previous section will apply to Part Two (Lines 11-18) but only is required to be filled out for business properties in which owners realized short-term capital gains and losses.
Form 4797 Instructions Part III: Gain From Disposition of Property
Part Three of IRS Form 4797 is the largest section and consists of 14 lines that require very specific information. For example, owners will need to report gains on Line 19 if they were realized under any of the following Sections:
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Section 1245
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Section 1250
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Section 1252
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Section 1254
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Section 1255
Previous owners who report gains under any of these sections will need to accompany them with the date they acquired the property and the date it was sold (also on Line 19). Lines 20-24 of IRS Form 4797 will consist of the gross sale price, cost basis, depreciation, and total gain for the subject properties in question.
Lines 25-29 require previous owners who realized gains or losses to fill out the information about each property, as it applies to the tax code. Finally, Lines 30-32 will ask applicants to add the appropriate lines to reveal the total applicable gains.
Form 4797 Instructions Part IV: Recapture Amounts
Part Four of IRS Form 4797 consists of four lines (Lines 33-35) and deals primarily with recapture amounts. To be clear, a recapture amount is a provision by which the IRS may collect taxes on any profitable sale applicants use to offset their taxable income. Once Part You is properly filled out, applicants may attach the completed Form 4797 to their tax return.
Summary
Real estate investors and business property professionals have a million things on their plate, and it can be overwhelming to take time out of your day to learn about proper tax filing. IRS Form 4797 instructions are, at the very least, complicated and hard for the average investor/business owner to comprehend. The form is filled with nuanced jargon that most people have never heard of before, let alone understand enough to file their taxes appropriately.
Nonetheless, Form 4797 is necessary for anyone who has sold or exchanged physical real estate they used for a business. This article was intended to simplify the process and hopefully make IRS Form 4794 slightly more bearable. With Fortune Builders’ helpful guide and step-by-step walkthrough, those who realized capital gains or losses on business properties in the current tax year should have one less thing to worry about when it comes time to file.
For real estate investors that have recently bought or sold multiple business properties that find filing Form 4797 especially overwhelming, they should work with properly trained tax professionals and Certified Personal Accountants who are well-versed in the intricacies of IRS Form 4797. Then, and only then, will they be able to rest assured of their taxes were filed correctly. When it comes to filing anything with the IRS, it’s always suggested to play it safe than be sorry for a small mistake discovered down the line.
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