Can I correct an incorrect cost basis for a rental property when it is sold? Does IRS allow the change?

[Carl]

this is a weakness in TT

Yes it is. No doubt about it. However, if you work through the rental section, mainly the Assets/Depreciation section to get and total up all the depreciation taken, then when asked for that in the Sale Of Business Property section you can enter that total and the program will complete the 4797 and the SCH D correctly. Assuming of course, you enter the correct amount of the total depreciation taken on the property for the entire time you owned it. Just remember that you also have to include the depreciation taken in 2020 also, up to the time of the closing on the sale.

While working through the SCH E assets/depreciation section, you should mark each listed asset as "removed for personal use" using the closing date of the sale. Only then can the program figure and present to you the depreciation taken for 2020.

[bob_brown]

@Carl yeah I have the depreciation in the sale of a business property it is $31,XXX for six years I get $5400 a year in depreciation at 6 years roughly it was only a half year in 2020 until June 2020.  I started in August 2020 so I get $31,XXX of depreciation.  I expensed all of my interest, utilities, repairs prior to sale on my schedule E and placed my Sale Proceeds from 1099-S and the cost of the property from my original settlement statement in "Sale of a business Property" under cost and added my settlement statement commission fees and other fees associated with the sale.  There is another box I for depreciation where I placed the $31,XXX.  My schedule E looks good....it says I sold it.  But when I look at the "forms" in TT it does not fill out Part I line 2 .......what a drag.  So if I get audited I guess since TT is lumping the amounts together I could get flagged for not filling in part I and indicating the land capital gains from the structure.  My gain was so little that we are talking about a miniscule error in tax.  I am not sure its worth IRS to even calculate the numbers separately and charge me the correct amount.  In addition with the house being vacant between the final months rent and sale I am not sure my schedule E is correct.  Are those truly "expenses" I guess if I could have rented it which I was considering then they are......man gotta keep your head on a swivel.  Or do those "expenses" become "selling costs". 

[Carl]

I know you're aware of this. But I'm making a point here. So bear with me.

If at the time you placed the property in service, the FMV on the date of conversion was less than what you paid for it, that means depreciation was figured on the lower FMV cost basis, and not what you actually paid for it. That means you flat out can *NOT* report the sale in the SCH E section of the program. Period. If you change the cost basis in the SCH E section, that will totally screw up the depreciation. So reporting the sale in the SCH E section is just flat out not an option.

You must convert the property to personal use in the SCH E section of the program. To do this, as you work through each asset you'll select YES on the screen that asks if you stopped using the asset in 2020. Then on the "Special Handling Required?" screen, you have to select YES. If you select NO, then you are "FORCED" to enter sales information. Since the SCH E section has the wrong cost basis for determining gain on the sale, you can't enter your sales information in the SCH E section. So that's why you convert the property to personal use with a conversion date the same as the closing date of the sale.

Then using the "correct" cost basis, you report the sale in the Sale of Business Property section, and in that section only.

[bob_brown]

@Carl Oh I am totally with you but some accountant will tell me I did not separate out the land from the structure on my 4797 form.  I am with you 100%.  This does have some implication with the tax paid because I am adding my land and structure with each other in Part III of form 4797.  TT gave me my total depreciation based on my FMV depreciation schedule from schedule E portal of $31,XXX with $2500 of that being in 2020 because it was a half year so it prorated it correctly.  My gain is so small on this property separating out the structure from the land and placing the land on Part I line 2 would have minimal affect on taxes.  Its not like a 100 acre farm with a house on it.....then that would have huge implications.  We are talking about a track home in ABQ.  My gut says go with what I have because in the end I have my documentation and I have my back up dated if audited.  I have all of my rental expense receipts from when the renters left in March through when it was sold.  IRS could ding me on the interpretation of PUB 527 for rental expenses while on the market to be sold with no renters in it.  I get it.....and they can ding me for not having Part I filled out on form 4797 and portioning the land value out.  But dang they would be squeezing blood from a rock....not like I am a high roller.....they would be expended resources to come after an honest dude.  I am a professional engineer not an accountant.

[bob_brown]

@Carl In reality TT needs to account for this.....all they need to do is add a section to portion out the land under "Sale of Business Property" portal exactly how it is in the schedule E how they have structure and land.  Without that they simply are not doing it right.  Freaking intuit......I need to call the software engineers at intuit and have a conversation it would be pretty straight forward.  As for my schedule E I think IRS does not want you double dipping on the rental expenses either make then "rental expenses" and put them on schedule E or make them "Cost to sell" and put them on 4797.  You cannot take them in both places that is why they have that rule about not taking them unless you have it listed for rent.  Either way they are eligible expenses in my opinion it just depends on who interprets Pub 527.  Ok I am just going to stick to buying stocks from now on this hurts my head and eats to much time up.

[Carl]

If anything, you could report two sales in the Sale of Business Property section, and then the 4797 would be right. Report one sale for the sale of the structure only. Then report another sale for the sale of the land only. That would put the 4797 in line with our interpretation of pub 527.When working it through for the sale of the structure you'd select YES on the screen that asks if you're reporting the sale of a depreciated asset. Then when working it through for the sale of the land you would select NO. I've included a screen shot as an attachment below, of the screen where you would select YES for reporting the sale of the structure, and NO for reporting the sale of the land.

I've never heard of anyone having issues with not separating out the land sale from the structure sale. When it comes to rental property, it all works out in the wash in the end. the "bottom line" is all the IRS cares about being correct. How you got to that bottom line, they could probably care less.

Generally though, if the property was not held out for rent while it was also up for sale, then expenses incurred after that last renter moved out can't be claimed as rental expenses. But that doesn't mean that at least some of those expenses can't be claimed as something else, such as sales expenses.

Overall though, since you point it out, I agree that the program should have the ability to separate out the land sale from the structure sale. After all, the program does specifically ask in the Sale of Business Property section, if you are selling real estate.

[bob_brown]

@Carl Yeah I tried your way and it does not put it on Part I line 2 of the 4797 form.  Let me try again and say no to depreciation.

[Carl]

Say YES to depreciation for the structure sale. Say NO for the land sale.

[bob_brown]

Jesus now it put both on Part I line 2 WTH!!

[bob_brown]

@Carl finally DID IT!!!!   You did it Carl holy hell.....you did it!!!!!!  Ok now I just gotta figure out the schedule E expenses.....I really think they are deductible I am going to see if they are.......its a big change because I have a lot of mortgage interest.

[Carl]

Glad to hear it works out. I wasn't sure it would. However, there's still one more thing to check. But you can't really check it until you have completed your tax return in it's entirety. Recaptured depreciation is taxed anywhere from 0% to a maximum of 25%, depending on your AGI. Of course, you can't know your tax bracket until you finish the tax return and get your AGI. So if  your AGI puts you in the 32% or higher tax bracket, that recaptured depreciation should only be taxed at the maximum of 25%.

Now I'm not sure (but maybe you can confirm) but I think the applicable percentage is shown as a decimal number on line 26b of the 4797. Note that the number can change, if you have not yet completed your tax return in it's entirety.

[bob_brown]

@Carl I did not see anything in 26b on form mode in TT.  Also I think I am going to keep my schedule E the same for now.  I think the "if it was not held out and available for rent" statement does not say anything about listed for rent.....it is after all a rental it is always going to be available for rent I live 2000 miles away.  It was never going to have any other use other than listed for rent or sold.  So if it did not sell it is available for rent.....I have communication with property managers to see about renting in case it did not sell.  I listed it during the initial stages of corona virus I had my doubts as the economy crumbled and the foot traffic dropped I sure as hell was looking to rent it. 

[bob_brown]

@Carl and separating out my land and structure only increased my tax liability by $25 in my case.  I can imagine someone where there is a disproportionate amount of land and the land went up in value for the rental that it could make a big difference.  But in my case it was $25.

[lisacslater]

You only have to file Form 3115 if you used an impermissible method of accounting (not claiming at all or any other incorrect method).

If you filed depreciation using the correct method but had an incorrect basis for depreciation - this is NOT what Form 3115 is for.