Basis has been severely undervalued by prior accountant for years. Should I change the basis this year?

[1isa]

Home purchase (2005) price was $330,534  

Prior (now retired) CPA had cost/basis at $99,504

1) Should I carry over exact same entry from CPA, or follow TurboTax prompts and enter actual price?

2) If I enter purchase price, should I declare prior CPAs prior depreciation (which is substantially less than what TurboTax assumes has already been depreciated) or disregard prior numbers altogether and simply follow the software prompts?

3) Any red flags by not staying consistent with prior filings?

The home was purchased as a rental.  No foreseeable future to sell as a rental.  Will reclaim as primary residence or be inherited should owner pass on.  Therefore, tax recapture should be irrelevant, correct?

[Cynthiad66]

@1isa

Tax recapture is key because depreciation is allowed or allowable.  The IRS requires that you recapture all allowable depreciation to be taxed (i.e. including the depreciation you did not deduct).

The proper way to fix this situation is to include the IRS Form 3115 - Change In Accounting Method form with your 2021 tax filing, to correct the depreciation. While this form is included with the TurboTax program, it's not simple by any stretch.

You will have to purchase a desktop version of TurboTax for Form 3115 and, basically, start over with that version.

However, even with the desktop versions, Form 3115 generally needs to be prepared in Forms Mode (there is virtually no guidance in terms of making entries). As a result, you might be better advised to seek guidance from a tax professional to prepare this form.

You should be able to e-file this form.  Use the search bar after you login to search Form 3115.  Use the link below for instructions for Form 3115.  Instructions Form 3115

[Edited 3/1/2022 9:04AM PST]

[1isa]

Is this necessary to correct, or shall I just carryon with prior accountant's figures for the sake of consistency? The method of depreciation appear to be the same S/L MM 27.5

[KrisD15]

To clarify,

was the home purchased for 330,534 as a rental or was it first a personal residence? Did the value drop from purchase to the time it was available for rent? 

What is the value of the land?

Is the land much more valuable than the improvements? For example, a mobile home on a lakefront lot?

Additionally, if prior rental property is inherited, the basis is stepped-up and there is no depreciation recapture required for the depreciation allowed or allowable before the transfer of ownership due to inheritance. 

[1isa]

Purchased as a rental. New build. Rented within few months of closing. 

Land value declared by CPA was 10% of low basis figure.  Tax records confirm 10% land ratio.

Chances are this property will end up being inherited/passed down to children with client having no intent to sell.  So named client is my mom. 😃

[DianeW777]

Your options are to file as is, keeping in mind that whether you used the depreciation or not, it will be recaptured at a point of sale, if applicable. Do not change anything without using Form 3115, determine the amount of depreciation that should have been used and deduct the full amount not previously used in the current tax return.  The IRS rules, as indicated by our awesome Tax Expert @Cynthiad66, is allowed or allowable.

As far as inheritance goes, the cost basis to the beneficiaries will be the fair market value (FMV) on the date of death. This will have no affect on the beneficiaries, as indicated by our awesome Tax Expert @KrisD15.

The depreciation expense is important to your mom right now and for this reason you should consider completing Form 3115, and if you are unable to do that you should seek a professional to assist you.

[Carl]

For rental property, the cost basis "for depreciation" is the LESSER of

 - What you originally paid for the property or,

 - The FMV of the property on the date it was placed in service

So if the property was purchased prior to 2008 and placed in service in 2008 or after, it's highly possible the FMV at the time placed in service was "in fact" lower than what you paid for it. So the CPA very well may have done it right.

Understand that you can't just arbitrarily change the cost basis of an asset. When you do that, it completely screws the depreciation history, and will make the current year depreciation wrong also.

If you are required to change the cost basis of an asset, then you have to file IRS form 3115 with your return to do that. The 3115 is included in the TTX program. But that form is not simple by any stretch. You'd be advised to seek the services of a tax professional for the 3115. Especially if your state taxes personal income.

But again, if the property was placed in service anytime after 2008, and before around 2013/14, the cost basis used "for depreciation" is probably correct.

[Mike9241]

if you inherit it, the depreciation issue goes away. your tax basis becomes the FMV on the date of death.  but until then if the wrong basis is used, there could be some tax issues if something else happens. get it corrected now.

[Anonymous_]

See https://www.irs.gov/publications/p946#en_US_2020_publink1000107386

We have been here before and I do not believe Form 3115 is going to be applicable when the wrong basis is used. That would not be an impermissible method of accounting, but more of a math or posting error.

See https://www.irs.gov/publications/p946#en_US_2020_publink1000107386

@AmeliesUncle 

[AmeliesUncle · Accepted solution]

I agree with Tagteam.  Form 3115 can not be used for an incorrect Basis (a "mathematical or posting error").

Use the correct Basis on the current return.  Leave the "prior depreciation" either BLANK or enter the amount of depreciation that SHOULD have been taken.

You may want to amend 2018, 2019 and 2020 to claim the proper depreciation and possibly get an additional refund for the extra depreciation deduction.  But as you mentioned, if she still owns the home when she dies, all of the depreciation disappears so it would not affect anything when it is sold (based on current tax law).