cost basis for sale of rental property affected by 2008 housing market collapse

[marmccar]

Hello.   My wife and I sold a rental property this year and I've got a question about how to report the cost basis for the sale.  The rental property was my wife's condo that she purchased in 2007 (before we got married) for $91900.  Not long after that, the housing market tanked and it lost more than 30% of its value by the time we got married 2011.

In 2012 we decided to rent it out because it was so far underwater we didn’t want to sell it.  When I filled out the TurboTax interview section for rental properties for that first year we used it as a rental property (tax year 2012), I entered the price my wife paid for it in 2007 ($91900) and then also entered what was the current market value at the time based on county tax documents which was $62700 (land: $10000, building: $52700) -- so, still quite far under what my wife paid for it in 2007.

Fast forward eight years to now and we’ve put around $15000 into the unit (we had a bad renter making up about half of that spend) and TurboTax has tracked depreciation of $13762 over the years.  We sold it in 2019 for $90000 (that's $1900 less than what my wife paid for it in 2007).  Given we sold it for slightly less than what it was purchased for and the amount we put into it ($15000) was about the same as the depreciation ($13762), my hope was that the sale would be about break even to slightly favorable when reporting it on my 2019 taxes.  However, TurboTax is using the 2012 market value of $62700 as the basis on form 4797.  Combine that with the $13762 in depreciation and I now have a total gain of over $40K with the sales price of $90K.  My question (thanks for sticking with me):  shouldn't the cost basis have been closer to $91900 (original purchase price in 2007) + $15000 (improvements put into the condo) = $106900?  Or am I out of luck because the market value of the condo had dropped so much by the time we turned it into a rental?

Summary:

Condo purchased in 2007: $91900

Converted to rental property in 2012: market value was $62700 after housing market tanked

Additions: $15000

Depreciation: $13672

Sold in 2019: $90000

Question: What should the adjusted basis be at the time of the sale?

Thanks for reading and for any thoughts you might have.

[taxes4sumting]

you have a split basis on converting to a rental so you have to figure a gain and loss separately. to figure a gain you use your purchase price plus improvement costs minus depreciation. to figure a loss you use the *****lesser***** of your adjusted cost basis on the conversion date and the FMV on the conversion date.

[Carl]

We sold it in 2019 for $90000 (that's $1900 less than what my wife paid for it in 2007).

So $91900 is not your cost basis in this property. You said: "Fast forward eight years to now and we’ve put around $15000 into the unit "

If those were property improvements, (I assume they are) then the cost basis is $106,900 now.

Note that you can't report this sale in the SCH E section of the program since your cost basis for depreciation was lower than what you paid for the property.  After you work through the SCH E section for the sole purpose of getting the total depreciation taken on the property and all assets over the years, along with the total of all carry over losses (IRS Form 8582), you'll report this sale in the Sale of Business Property section. This will be the only way to use the correct cost basis without screwing up the SCH E data.

[marmccar]

Thanks, everyone.  I did some more digging and found  Publication 551, Basis of Assets covers properties converted to rental on page 10 under “Property Changed to Business or Rental Use”.  In my case, I have to use the FMV on date of conversion (then add improvements and subtract depreciation).  Not a real favorable rule for me this time but that’s the rule and at least I proved to myself TurboTax was handling it right.   Thanks again for the help. 

[AmeliesUncle]

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@marmccar wrote:

I have to use the FMV on date of conversion (then add improvements and subtract depreciation).  Not a real favorable rule for me this time but that’s the rule and at least I proved to myself TurboTax was handling it right.   Thanks again for the help. 

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No.  You are misreading the Publication, and TurboTax does NOT handle this correctly.

Using the numbers you have shown, in your case you have neither a gain nor a loss.   TurboTax does NOT handle this situation, and  you need to either manually manipulate the numbers or go to a tax professional.