What would have prevented the form being created since 2013 when we bought and started renting the property?
While it's not self-evident to you, it's quite obvious to me. Will take a bit to explain.
Apparently, every year you've been seasonally renting the property out, you've been converting the property from personal use to rental, and then a few months later in that same tax year you converted it back from a rental to personal use. Unfortunately, that was wrong for your specific situation. Here's what happened and why. I'm picking dates and numbers out of this air here, just so you get a basic understanding.
- Converted from personal to rental on Jun 1
- Used cost basis of $100,000, allocating $30K to the land. So depreciation was done on $70K based on a MACRS 27.5 year depreciation schedule to fully depreciate.
- Got $1000 of depreciation for the year.
- Converted property back to personal use on Sept 1
The NEXT YEAR
- Converted from personal to rental on Jun 1
- Incorrectly used the same cost basis of $100,000, allocating $30K to the land. So depreciation was based on a MACRS 27.5 year depreciation schedule based on an incorrect cost basis, with the 27.5 year count starting over (incorrectly) in the 2nd year, "as if" if was the first year.
I should not need to carry this scenario on any further. You should get the "gist" of what happened here. Your first year's depreciation went to "la-la land" when you itold to the program the 2nd year, was the first year.
So in order for things to be correct, in the 2nd year you should have reduced your cost basis (on the structure only) by the amount of the prior year's depreciation. Then you do that "every year" you convert the property to rental and then back to personal. Then your numbers upon reporting the sale would not have gotten your attention.
For the carry over losses, if you "actively participate" in the rental activity each year, and have the "other" (non-rental) income to deduct those losses from, then once your rental expenses gets your taxable rental income zero, you are allowed to deduct up to $25K of the left over losses from that "other" ordinary income - such as W-2 income you received in the same tax year. So it's very likely that you don't have any carry over losses. (I'm not saying you don't. I'm saying it's a "possibility" you don't.)
What would have been easier and correct, is if you just left the property classified as a rental for the entire year, and all years beyond that first year. Then you just report the days rented for what they actually are, and the days of personal use for the remainder of the year.
Then enter total expenses and let the program "do the math" to allocate between the SCH E and SCH A accordingly.
This would then have allowed the program to keep track of your depreciation history and carry over losses. As it stands now, this is a real whammy for you. On top of that, if your state also taxes personal income that makes it a double-whammy. Since you sold the property in 2020, this "will" raise flags with the IRS. I would highly recommend you seek professional help for your 2020 taxes to get this sale reported correctly and in a way that will significantly reduce (hopefully!) the probability of an audit 24-36 months down the road.
