Depreciation deduction/cost basis error?

[vtdrevil]

I purchased a condo in 2006 and converted it from personal use to a rental it in 2015. 

The FMV at the time it was put in service ($320,000) was lower than the original purchase price ($389,000) and I used the lower FMV as the cost basis with 20% allocated as land 80% as building although that didn’t match the latest property tax document which had land allocated as 70%, building as 30%.  I am in California.

In 2017, a tax professional told me that I should have originally used the land/building % split as it was on the property tax document for the depreciable cost, and that I was currently depreciating and taking too high of a yearly deduction.  She advised that I change the depreciable cost when completing my 2017 return, and that Turbo Tax would automatically recalculate the depreciation for the current and subsequent years.  She advised that amending the prior years’ returns was not necessary since it would recalculate and I didn’t do so.  This has resulted in me taking about $6000 less in depreciation deduction each year since that time.

Now I am getting ready to sell the property (the sale will close in 2020) and was advised that since I never amended the original 2015 taxes, the IRS will use the higher cost basis I first reported in determining depreciation recapture, even though I have been deducting a lower amount based on the revised depreciable number from 2017.  Or will the IRS have a record of the revised lower depreciable cost number as I can see on the Depreciation and Amortization Report from 2017, 2018 and 2019?

What would you recommend doing at this time? 

Is there a way to file for 2020 that will enable me pay the recapture on what I have actually deducted over the years and not have to amend prior returns? 

Or do I need to amend the 2017, 2018 and 2019 returns to switch the depreciable cost number back and then take the higher depreciation based on the original reported cost from 2015?  This would likely result in some type of refund to me for each year and I think passive loss carryovers for two of the years.  Would doing this make me more likely to be audited?

I’ve been trying to do the right thing the whole time and I’m looking for the best solution that involves me not paying more than I should have to, while also not setting myself up for being more likely to be audited.

The sale of the property will be complete in 2020.

Thank you in advance for any advice!

[AmeliesUncle]

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@vtdrevil wrote:

Now I am getting ready to sell the property (the sale will close in 2020) and was advised that since I never amended the original 2015 taxes, the IRS will use the higher cost basis I first reported in determining depreciation recapture, even though I have been deducting a lower amount based on the revised depreciable number from 2017.

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No, that is not correct.  Just because 2015 was wrong, does not 'lock' you into a lifetime of wrongness.  The gain/loss is calculated using the actual Basis (70%).   In the unlikely event the IRS were to question it, just provide documentation of the actual Basis (70%).

The depreciation is "allowed or allowable" on that correct actual Basis.  That means the greater of the depreciation that you actually took versus the depreciation that you SHOULD have taken (based on the actual 70%) will be used.  So the higher-than-should-be amount from 2015 will affect things a bit, but as I said before, that does not mess up every other year.

So there is really nothing to worry about.

However, in most cases TurboTax is NOT set up to deal with reporting a sale like yours (the Fair Market Value was less than your cost when it was converted to a rental), so you may consider going to a tax professional for your 2020 tax return.

[vtdrevil]

Thank you for the quick response!  The lower depreciable cost that I changed to in 2017 was from 80% building in 2015 to 30% building in 2017, not 70% building.  30% allocation for the building is what showed as the improvements/total land ratio on the property tax bill.  I originally used 80/20 with building being the higher based on research and reading I had done online at the time when I was originally trying to figure this all out.

So is 30% what is actually allowable since I have property tax statements showing that ratio?  Or is that not the case with a condo where the property tax statement shows the land as worth so much more than the building?

The advice I received yesterday was that the actual number used as the depreciable cost wouldn't be an the issue if it had stayed consistent throughout the time the property was rented.  So if I had initially used the 30% improvements/70% land off the property tax bill in 2015 and kept it that way, it would have been fine.  And if I had used the 80% improvements/20% land and kept it that way throughout, that would have been fine, since both can be rationalized.  But I understood that the biggest issue was the fact that I changed what I was using as the depreciable cost two years into renting it, and am now using a different depreciable cost from what I initially submitted as the basis for depreciation on the 4562 in 2015, even though I can rationalize it.

If that is not a problem though, I do have the property tax documentation, and am happy to pay recapture on the extra I deducted in 2015 and 2016 that I shouldn't have deducted if 30% is the actual Basis.

[Carl]

Based on my understanding of this thread (and I'm not 100% confident I understand it correctly) you can not report your sale in the SCH E section of the program, since your depreciation value was less than what you originally paid for the property. What you have to do in the SCH E section is show the property and each individual asset in the assets/depreciation section as converted to personal use on the closing date of the sale (or before that date if applicable).

Then you will report your sale in the section for "sale of business property". When asked what you paid for it, you can enter what you "really" paid for it, plus the cost of any property improvements if any were done under your ownership.

When asked for the total of all depreciation taken, you must enter the "higher" of the depreciation actually taken, or the total depreciation you "should" have taken during the period of time from when you converted it to a rental, until you converted it back to personal use.