Claiming catch up depreciation when changing rental asset from a room in my home to the whole home.

[tomandjerry1]

I had a few years of renting a room in my home and failed to include a deduction for depreciation for those tax years since I incorrectly assumed depreciation should only be used when renting the entire house.   I was wrong.  Now I am renting the entire house and realize I should have been including a depreciation component for the fraction of my home the room rental represented.   So this year I plan to file Form 3115 together with my FED taxes to include the additional "catch up" depreciation deduction.   I believe I understand the process and how to fill out Form 3115 but have a couple of questions regarding how to answer TurboTax interview questions.   Even though I failed to include depreciation for those prior years (too many to just file amended returns)  I should still let TurboTax assume I had been claiming depreciation for those prior years so that it will compute the correct depreciation deduction for this year.

Then I will  compute the catch up amount separately and include this as an "other expense" on line 19 with description "Catch up depreciation from Form 3115".  So the question I've got here is what value should appear in the "Total Depreciation Claimed in Previous Years" interview box. I've assume I should not put 0 in this box so that TurboTax computes the correct amount for this year.  Also, the catch up depreciation for the earlier years (2019-2023)  must use just the starting basis value for the fraction of the home the room represents.    Will this fly?  I understand that to include Form 3115 with my return I won't be able to eFile.  

Lastly, the rental property is in Vermont.   Any idea whether I need to file something analogous with my Vermont state return? 

[ThomasM125 · Accepted solution]

For the prior depreciation, you should enter what that should have been, which will be the amount of your Form 3115 adjustment. The catch up depreciation would just use the portion of the house applicable to the room that was rented. The Vermont return will work off of your adjusted gross income on your federal tax return, that will include the depreciation adjustment, so there is nothing special that needs to be done there.

[tomandjerry1]

Great.  Thank you so much.  After a bit more research I believe I've come to the same conclusion as yours. I must file Form 3115 with this year's return and use the catch up value I've calculated with that form to answer TurboTax's question regarding prior years depreciation. 

As for handling the switch from renting just a part of the property to the entire property, I think I  understand this now too.  For the first N years that I rented just F% of my property, with initial full property basis PB, I should compute N years of straight line depreciation using the starting basis F*PB.  So that would be  ( (F*PB) / 27.5 ) each year, for N years.   Then in year N+1 and onwards, the starting basis for the remaining life of the property is  PB - ( N * ( (F*PB) / 27.5) ).  That is, I reduce the basis by the amount of depreciation I've already taken, and then use the straight line formula for the shortened useful life, which is then  (27.5 - N),  applied to the adjust full property's basis.    I'm pretty sure that's exactly how TurboTax has used the value for "prior year's depreciation" to determine the depreciation deduction amount for this year's return. 

One  last comment pertaining to depreciation calculations.  I believe that the midmonth convention requires that the first "rental use" month is always treated as half a month, so that the 1st year of depreciation must always be reduced accordingly by 1/2 a month's worth.

One last point, I've seen a fair number of comments regarding the nightmarish 8-pages of Form 3115  mishmash which one must navigate when attempting to correct missing deprecation.  It strikes me that this is probably a pretty common error/oversight of many casual AirBnB hosts who use TurboTax.  In fact, I've come across more than one criticism of TurboTax for failing to include a resounding warning when one includes rental income while also failing to include depreciation. 

Are you listing Intuit?  How about a warning that once you start using your home to generate significant rental income, then depreciation is not really that optional.  And maybe make it as prominent as the recurring upgrade purchase offers?

As for the Form 3115 nightmare,  I was somewhat bewildered by the dearth of applicable Google results when attempting to find useful tutorials on using Form 3115 to solve this one specific, and I assume pretty common, problem.  I eventually did prevail, and believe I've somewhat descrambled Form 3115, at least for this specific objective, so I will return to this topic, once the tax season tomfoolery is behind us, to share.

THANKS AGAIN!!

[tomandjerry1]

I'm still a bit unclear about how to deal with the depreciation situation when changing from renting a part to all of a property.  It's my understanding that during the period I rented out just F% of my residence, then each year's depreciation deduction would be computed using that year's straight line depreciation based on  F% of the full property's basis.  Then, after Y years say, I start renting out the entire property what happens?  Would I just switch to using straight line depreciation on the full property's basis for the  remaining years of useful life?  Has the full property's basis been depreciated during the period that I was only renting out F% of it.   Instead maybe I could then take the unused portion of the depreciation in those Y years as an additional "catch up" amount in year (Y+1).     What's not clear to me here is that while I was only renting a fraction of the property, and only taking a fraction the total depreciation, was the whole property still being depreciated each year anyway?  If that's the case then just renting out a room, say, seems like a really unsound financial proposition!  Is there another approach to handling the change in year Y+1?

Perhaps I'm overthinking this?  Maybe the simple (obvious?) solution is at year Y+1 continue the SL depreciation on %F of the original basis ,and then start a 2nd SL depreciation for the remaining (100-F)% of the basis (as though this were an "improvement").   The net effect each year after Y+1 is a deduction that amounts to the simple SL depreciation for one year on the total basis, but the two components would just have different useful life spans  

[DianeW777]

It depends. If you rented the full property in 2024, then you can change your percentage to 100% and use the full cost of the property for depreciation. Keep track of the depreciation you used for part of the property by keeping the information with your tax files until you actually sell the property. 

No, the whole property was not being depreciated when you were using only a percentage if that percentage (days and/or square fee) was entered into the rental asset. It's up to you but you can remove the partial rental using the steps below (enter the date of the change as the last day). Next add the full asset at 100% but with the new date beginning in 2024. 

Finish Partial Asset: Based on earlier discussions you will use this full amount from 2019-2023 as an expense using Form 3115. Be sure to enter the starting date of 2019.

When you are in the rental activity for 2024, you must select the 'Assets' section, then in each asset you must go to the screen titled 'Tell Us More About This Rental Asset'. 

1. Once you reach this screen for each asset, you must select 'This item was sold, retired, stolen, destroyed, disposed of, converted to personal use....' 
2. Next enter the date you stopped using the asset for rental purposes. And answer 'Yes' you always used this asset 100% of the time for business. (The percentage of use doesn't change until after conversion from rental to personal use.)
3. Select 'Yes' for Special Handling due to 'You converted the asset to 100% personal use'.

You may see some depreciation expense which will be the partial year amount.  For the period of the year it was available for rent, you may have some expenses which are allowed for that open period.  Keep all of these records because you will need them when and if you sell this home. All depreciation will be recaptured at that time, regardless of how long you hold the property for personal use. The records are necessary until you completely dispose of or sell the property.

Start the Asset for the Full Amount: Simply add a new asset and enter the full cost including land, then enter the land when asked. TurboTax will use the difference when calculating depreciation. The depreciation will be straight line mid month (SLMM) over 27.5 years as was on the partial rental.

@tomandjerry1