How can I correct the amount of depreciation on a rental property after it was sold?

[ebbywhit]

I sold my rental property in July. In preparation for filing my 2017 return, I noticed errors in depreciation claimed from 2012-2016. The rental was converted in 2007 and has a basis of $100,900.  The correct amount of depreciation was claimed from 2007-2011 but I changed software in 2012 and the incorrect basis was inadvertently calculated.  This has resulted in under claimed depreciation of $4,909 as well as under reported passive losses for the same amount. The losses would have been unallowable due to income but I want to be able to use in order to offset gain on sale.  As of 2016 and as filed, I have $25,812 in prior year losses and the estimated gain realized using the correct (allowed depreciation) would be $28,460.  Technically my losses should be $30,721 instead of $25,812.  Can I correct this error so I will be able to use the $4,909 in losses not reported from 2012 to 2016 to offset any capital gains on the sale? Can I use form 3115 or is there a better way? 

[aquaphyte81]

I am in a similar situation I would like to know how/if to possibly correct past under reported depreciation. Also does this affect the tax basis reported when selling a rental for a gain? Everything I've read says that when selling a rental for a gain, you use the purchase price, even if you converted it to a rental at some point during its life.

[TaxGuyBill]

@aquaphyte81   Can you explain the "under reported depreciation"?  Give as much detail as possible.

Yes, the depreciation that you COULD have taken reduces your Adjusted Basis.  If it was sold for more than that Adjusted Basis, yes, you use the purchase price.  If it was sold for less than that, then it depends on some other things (such as the Fair Market Value when it was converted to a rental).

[aquaphyte81]

Thank you TaxGuyBill, I can't believe how many CPA's I've tried to talk to about this, clueless. I'm still trying to find one that gets it. Basically when I first started claiming depreciation, I used the local county tax assessors valuation of the property, which of course in hindsight was a bad idea. By my estimation I may have depreciated it at 50% of what I should have, and now that I've sold the property that is an issue with my claim. I've read that IRS rules changed in 2014 to allow for catch up depreciation to be claimed on a sold asset via 3115. No one seems to know/understand this, so my search for CPA continues.

[aquaphyte81]

When I'm in turbo tax as well, and inputting the information, it gives you the option of changing the figure that the program inputs as your expected depreciation. I WAS going to just put in there the amount that I actually depreciated, but I thought better and said, wait, maybe in need to check on this before I do that. I do find it interesting that the tax software MIGHT allow you to do something like that if it wasn't an ok thing to do. WHY make it an option in the software? Is the IRS expecting you to put the full allowable depreciation in your return regardless if the actual depreciation (lower in my case) is clearly recorded in past returns? CONFUSING.

[TaxGuyBill]

The only thing you can do is amend.

There wasn't any change in 2014 in this regard (but there was a clarification for disposed property in 2007, and the Revenue Procedures were revised in 2015).

Although Form 3115 can be used to 'catch up' on the missed depreciation, one requirement is the you must used an "Impermissible Method of Accounting".  I've seen some people assert otherwise, but the Revenue Procedures clearly say it "applies to a taxpayer that is changing from an impermissible method of accounting for depreciation to a permissible method of
accounting for depreciation".  Although not claiming ANY depreciation is "impermissible", claiming the wrong amount is not "impermissible" (it is a "mathematical or posting error").  


As for the software, you should put what you SHOULD have taken.

It is an option in the software because if your business percentage varied over the years, TurboTax does not keep track of that, so you would need to enter the proper amount (otherwise TurboTax assuming the current year's business percentage has always been used).

Yes, you need to enter the full amount of depreciation you COULD have claimed.  In the event the property qualifies for the 2-out-of-5 year exclusion for using it as your Main home, there is an interesting exception (sort of) that TurboTax doesn't handle.  In the event that applies, please post back with details about when it was your Main Home.

[aquaphyte81]

My returns show that I took $10963 in depreciation, turbotax is saying $20520
When you get to this point in the program it says the following -

"Select Continue to accept these amounts. Otherwise, correct the amounts and select Continue. Where can I find this?"

When you click on "Where can I find this?" it says the following

 "- If you started using the asset before 2016, then look for 2 numbers: the 2016 depreciation amount, and the prior or accumulated depreciation for 2016. The sum of these 2 numbers is your prior depreciation for 2017."

Which is where I got the $10963 figure, so why is it telling me to put this in?

So what do I do??

[TaxGuyBill]

As I said, you enter what you SHOULD have taken (which is probably $20,520).  It assumes your prior tax returns are correct, in which case you would have claimed $20,520 of depreciation.  That corresponds with your comment that you have been claiming about 50% of what you should have.

[Opus 17]

You would file a form 3115 to correct the depreciation error.  This is a complicated matter not supported by Turbotax and usually requires an accountant.  You could try Turbotax Live (the most expensive version, with CPA/EA help) or see your own accountant.

[TaxGuyBill]

You can't use Form 3115 to correct an incorrect Basis.  That is not a Change in Accounting Method.

The only way to partially fix it is to amend the 'open' years.

[TaxGuyBill]

Actually, now that I think about it, this could fall into a weird "gray area" for amending.  The tax is not changed, or it is possible you could hypothetically amend non-open years, and/or you can calculate the proper losses anyways because they did not affect the prior year tax returns.  I am unsure if either or both are allowable.

[ebbywhit]

I was hoping I could fix it on my 2017 return. If I were to amend the open years, there would be no change in tax so amending would really be just an administrative correction.  I am calculating my basis for capital gain using the correct amount of depreciation.  The actual realization of the prior year losses would be in 2017 and since the property is being disposed, there is no future benefit to me. It seems logical but I need to figure out if it's allowable.

[aquaphyte81]

Hoping for answers on this too

[kelly-mcpherson]

Looking for answers for this too.  Purchased a home in 2004 with my brother for 244K and then bought out his share in 2015 for 83K.  Used 83K for deprecation beginning in 2015 when it was used for a rental. But should have used the full purchase price. Value of house is now 240K.  I bet if we sold it we would have capital gains even though it is 4K less.

[TaxGuyBill]

@kelly.mcpherson   As I said above, you need to amend your prior incorrect tax returns to claim the correct depreciation.