Depreciation of Rental Property not Continuously Rented

[ludoviclalo]

I would like to know how to depreciate a rental property that was rented out years ago, then stopped being rented for years, and then rented out again after a break in between rental periods of many years.

I purchased my condo on 05/29/2001 to rent out.  I rented it out 08/01/2001-08/03/2003.  I treated it as a second home 08/04/2003-06/30/2021.  I rented it out again 07/01/2021-present.   

I researched this in 2021 when the property became a rental again, but I think I misunderstood what I read since on reviewing my 2021 tax return I can't determine how Turbotax came up with the depreciation amount.  I looked at my 2021 tax return in-depth (which I should have done before filing it) because on my draft 2022 tax return Turbotax has a much larger depreciation amount that I also have no idea how it was computed.  

I thought that I could just pick up my depreciation in 2021 as though it was the 4th year on the 27.5 depreciation schedule, but something else is going on.  The Asset Entry worksheet shows 22 as the year of depreciation, but how can that be since I only rented the condo for 4 years (2001-2003, 2021)?  It looks like because Turbotax used 22 years the AMT depreciation amount is kicking in since Turbotax applied an AMT adjustment to my depreciation which makes the depreciation amount much larger.  

I am still researching what the AMT adjustment is on depreciation, but is it right that even though my condo was only rented 4 years with an 18 gap between the first 3 years and CY2021 that I need to include the depreciate the gap period too?

Thanks.

[PatriciaV · Accepted solution]

You are correct that you began depreciating your home as a new rental in 2021 and should not have entered the original date it was first used as a rental. To correct this, you will need to amend your 2021 return and fix the in-service date for the property. This will recalculate the depreciation beginning on the 2021 date.

Also, you probably reported an incorrect basis for depreciation. Both the in-service date and basis are reset when you converted the property back from personal to rental use.

According to IRS Pub 551 Property Changed to Business or Rental Use: 

If you hold property for personal use and then change it to business use or use it to produce rent, you must figure its basis for depreciation. An example of changing property held for personal use to business use would be renting out your former main home.

The basis for depreciation is the lesser of the following amounts.

• The FMV of the property on the date of the change, or
• Your adjusted basis on the date of the change.

The best source for the Fair Market Value (FMV) on the date of the change would be a local real estate agent who can provide comparable sales. This is good evidence for the value of your home on that date.

Your adjusted basis is the original purchase price plus any improvements (upgrades or additions) that you have made, less the accumulated depreciation taken on the property if it was previously used as a rental. Historical property tax records may provide the price you paid for the home. Improvement costs and accumulated depreciation would come from your personal financial records.

In most cases, your adjusted basis would be less than the FMV, so that is the basis you would use for your converted rental property.

Your best option is to request an extension of time to file your 2022 tax return. This will allow you to prepare and file an amended 2021 return so you have the correct information to enter for 2022. As a final note, the amended return is a correction to the depreciation you reported. It is not a change in accounting/depreciation method.

[ludoviclalo]

Thanks!  I need to look at Pub 551, but your response makes sense in retrospect and after doing some experimenting on my 2021 tax return.  I have a confirmation question though about how to enter the adjusted basis in Turbotax.

I looked at my 2021 tax return in the 2021 version of Turbotax Premier (not online, the installed version on my computer) and don't see an "adjusted basis" field per se.  Moreover, a "Confirm Your Prior Depreciation" section with a field for me to enter depreciation prior to 2021 (this is the cumulative depreciation that I apparently erroneously entered for 2001-2003) does not come up unless I enter 05/29/2001 (or some other 2001 date) as "Date I started using it in this business."

It sounds like I need to enter the adjusted basis in the Cost field (not in the Cost of Land) field in the "Tell Us About This Rental Asset" section instead of the actual purchase cost on 05/29/2001.  When I do this and enter 05/29/2001 as the purchase date and 07/01/2021 as the date that I started using it in this business field the "Confirm Your Depreciation" section does not display.

I sounds like you are saying and I am assuming based on how Turbotax works after doing the above experiment on my 2021 tax return, is that I basically treat the condo as essentially being rented for the first time in 2021 instead of 2001.  However, instead of entering my original cost from 2001 and depreciation in 2001-2003 and 2021, I enter the cost adjusted for any depreciation taken up to 2021 and then Turbotax will depreciate the cost (adjusted basis until 2021 cost, not my original 2001 cost) entered on my 2021 tax return in future years as a rental property. 

[DaveF1006 · Accepted solution]

Actually the way this is suppose to work is the following. 

1. Since you rented the house out years ago and taken depreciation (or should have), hopefully you have a record of that deprecation. You will need this for an adjusted cost basis for your new deprecation schedule.
2. Now since you have started renting again, the will put this rental on a new 27.5 yr.  deprecation schedule.
3. When you are asked about the cost basis, be sure to subtract the depreciation from your original cost basis for the home and this becomes the new basis for the new depreciation schedule.  This is an adjusted cost basis.  
4. To keep it simple, I would treat this like a new rental but remember to use the adjusted cost basis as a described above and not the original basis. This will reduce errors that may occur if the information is entered incorrectly.

[ludoviclalo]

Thanks for the answer and promptness.  I depreciated the condo for the 3 earlier years and have records for it.  I will subtract the cumulative depreciation for these years from my original costs basis for my adjusted cost basis for the 2021-present rental period.  I read up on this some first now that I know what's going on and how I messed up.