This question is about federal income tax on the sale of a rental property, in a situation when the property ownership has been transferred between spouses.

The situation in question involves a married couple; let's call them Alice and Bob. They always file a joint tax return (Form 1040).

Bob purchased a rental property for $150,000. He was the sole owner, and he held (and rented out) this property for five years. Every year, he was deducting straight-line depreciation (on his joint tax return with Alice, Form 1040), which was $5,455 per year, and thus he deducted $27,275 total over five years.

After five years, Bob transferred the ownership of that rental property to Alice through "quitclaim deed", and Alice became the sole owner of that rental property. Then, Alice sold it for $220,000 (before the commissions), and paid $20,000 sales commissions. According to Form 1099-S generated during the sale, Alice received $220,000 of the sales proceeds (before the commissions).

How should Alice and Bob report the income from the sale of that property?

Can they simply calculate their joint income as

$220,000 (sale) - $20,000 (commission) - $150,000 (purchase)
+ $27,275 (previously deducted depreciation)

Or should they report their income as two separate taxable transactions:

(1) The sale by Bob to Alice for $0, which resulted in the LOSS of
$150,000 (purchase) - $27,275 (previously deducted depreciation)

(2) The sale by Alice for $220,000, which resulted in the PROFIT of
$220,000 (sale) - $20,000 (commission)

Please help. Thank you.