Can I deduct improvements to rental property not depreciated?

I put a rental property in place in 2010, but had done quite a bit of improvements to the property before putting in service. I only put the cost of the unit on my depreciation schedule, and none of the improvements were recognized as an expense. I sold the property in 2019, can I claim the improvements as an increase to the basis at the time of the sale? These were all related to increasing the property's value (renovating interior, new appliances, etc.) that in hindsight I would think should be deducted. 

 

Thanks!

Carl
Level 15

Investors & landlords

No. You can not just add the improvements done prior to 2010 to your cost basis. It just doesn't work that way. As I'm sure you're aware by now, property improvements are required to be depreciated the same as the rental property itself, from the time that property improvement is place "in service". You did not to that. So you have depreciation that you did not deduct each year on those improvements, over the last 9 years.

Therefore to correctly fix this in accordance with federal law, you are required to include with your 2019 tax return IRS Form 3115 - Change of Accounting Method. This will account for your error over the last 9 years, and you can fully expect to pay a penalty. How hefty that penalty and/or fine will be is directly related to the cost of the property improvement. In some cases, it can completely wipe out how much of your taxable gain on the sale that you *will* pay taxes on, but won't get to keep.

While the Turtbotax program does include this form, I can assure you this is not simple by any stretch of the imagination.  While professional help in fixing this will cost you money, it will be a pittance in comparison to the fines and penalties you will pay to the IRS. On top of that, if your state taxes personal income you can expect some fines and penalties there too - a double whammy.

So you should seek professional help for dealing with this. More often than not a tax professional can at least reduce the amount of those fines and penalties you *will* be assessed.

If you attempt to deal with this yourself your changes of doing the 3115 wrong, thus resulting in more fines and penalties are very high, as in incorrectly completed 3115 practically guarantees an audit - and in your case they'll be auditing your tax returns for 9 years back, or more.

For the sake of your wallet in the long run, seek professional help from a tax professional in your local area. That way, I don't have to bite my tongue in the future to keep myself from saying "I told you so". 🙂

 

 

Investors & landlords


@kawsock wrote:

I put a rental property in place in 2010, but had done quite a bit of improvements to the property before putting in service. I only put the cost of the unit on my depreciation schedule, and none of the improvements were recognized as an expense. I sold the property in 2019, can I claim the improvements as an increase to the basis at the time of the sale? These were all related to increasing the property's value (renovating interior, new appliances, etc.) that in hindsight I would think should be deducted. 

 

Thanks!


Expenses to the property itself should have been part of the Basis that you depreciating.  If you did not do that, you have not been taking enough depreciation.  Yes, those items increase your Basis, BUT you also need to enter the depreciation that you SHOULD have taken.  The end result is that you have been missing out on 9 years of depreciation for those improvements.  Doing your taxes yourself seems to have cost you quite a bit of money in extra taxes.

 

As for things that are not part of the property itself (such as appliances), those too should have been depreciated.  Those would have been fully depreciated by now, with a Basis of zero.  So no, those don't increase your Basis now.  But there is a provision to 'catch up' on that missed depreciation, but TurboTax does not support that and I would recommend a tax professional for  that.

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