How do I enter a sale of rental property with stepped up basis asset and original asset in asset summary?

[TurbUser102x]

I can't seem to get a straight answer from anyone in TT live help or experts in forum here.   How do I enter the sale of a rental property that has the original basis/asset and the stepped up basis asset in the asset summary of the rental?  There is a stepped up basis due to death of spouse previously, so there is the original asset in the asset summary for the rental and a "new" asset with the stepped up basis of 1/2 original basis + 1/2 FMV on Date of Death.  State of Ohio here, not a community property state.

1. Do you leave the original "asset" for the rental in the asset summary alone by leaving it at full value/sale price etc as originally entered?  Do you put the full sale price at date of sale in when declaring the rental as sold?  It will recapture all the depreciation though instead of 1/2 of depreciation which I'm not sure is correct if doing it this way since spouse should only have to recapture 1/2 of the depreciation taken from original basis.

2. When you enter the New Asset for the rental property in the asset summary do you put the new basis in as the sum of 1/2 original basis + 1/2 FMV at DoD, or do you also subtract out 1/2 of depreciation taken from original/previous basis from the sum of those two values?  I also understand the service date will be DoD.  When property is sold, do you just put in the full sale price?  It will automatically calculate the depreciation taken from DoD to date of sale and recapture accordingly.

Another question is around whether or not you put in the full values for the assets instead of trying to make the old original basis asset 1/2 of the value it was and the new asset 1/2 of the FMV and then put sale price in as 1/2 of price for each when listing sale.  All the threads in TT on this topic seem to show different methods.  Just looking for CLEAR instructions on how to enter the sale in for a rental that has the original and stepped up basis assets in the asset summary.

Appreciate any help if possible!

[DianeW777]

It depends.  It's not clear when the date of death occurred, however since you are trying to figure out how to enter the stepped up basis for half of the property then the easiest way to handle the sale is not to add a second asset.  Instead, add the stepped up or increased value amount on the date of death, for half the rental house to your expense of sale for the original house asset.  This will provide the correct capital gain and depreciation recapture results for the sale.

The depreciation recapture should apply to the entire amount of depreciation used before the sale if you jointly reported the rental activity prior to death.

That being said, first we will look at how the sales price and sales expenses should be applied to all assets involved in the sale.  

The IRS requires that the selling price be proportionately prorated to arrive at a selling price for each 'piece' of a rental property since many assets can be placed in service at different times, such as improvements.

The selling price should be prorated for each asset then entered for each asset when you indicate they were sold or disposed of. You will not lose the remaining depreciation because you will use the remaining basis against the selling price to determine gain or loss. 

To figure out the selling price for each asset:

1. Take the current basis of each asset against the total combined basis of all of your assets to figure out the sales price for each one; OR 
2. Determine a fair market value for each asset against the total value of all assets to figure out the sale price for each one.  

Use the original cost of each asset listed on depreciation, add those together then divide each one by the combined total to find the percentage of the cost for each asset.  Use that percentage times the sales price and sales expenses to find the selling price/sales expenses for each asset.

Example:  Original Cost (of each asset on your depreciation schedule)

$10,000 Land                = 13.33% 

$50,000 House              = 66.67%

$15,000 Improvements  = 20%

$75,000 Total                 = 100%

Multiply each percentage times the sales price/sales expenses to arrive at each individual sales price/sales expense.

You need to dispose of the property by telling TurboTax how and when it was disposed of.  Follow the instructions below.

1. Click on Income & Expenses
2. Under Your income and expenses, scroll down to
3. Rental properties and royalties, click Edit/Add
4. Do you want to review your rental?, click Yes
5. Under Rent and Royalty Summary, click Edit
6. Click Update to the right of Assets/Depreciation.
7. Do you want to go directly to your asset summary?, click Yes and Continue
8. Click Edit to the right of each asset to be disposed
9. Go through several screens until you get to Tell Us More About This Rental Asset
10. Click on This item was sold…….   And continue to answer the questions

You might also review information here.

[TurbUser102x]

Thank you so much for the reply.  One question on the method of adding the stepped up basis amount (1/2 of FMV) to the expenses though... I like that option by the way!  But that will take into account the full amount of depreciation.  In reality, the spouse should only have to recapture 1/2 of the previous depreciation, right?  Plus there is an amount of depreciation that would need to be recaptured from date of death until date of sale on the new basis.  Hence why I think you need the new basis added in the first place in the asset summary.  So really my question comes down to how to report the sale for both the old asset up until date of death and new asset from DoD to time of sale.  The date of death was in 2017, so the old asset just sits there in the asset summary and has no depreciation being taken out anymore.  The new asset starts from DoD and goes until sale date and has depreciation associated with it.

From what i see in Turbo Tax, you cannot take something out of service for personal use without saying it was sold... seems to be a flaw.  

Still baffled on how to do this the correct way in Turbo Tax and now there is another option or method to consider.  But if you can explain how it knows how to correctly take out the right depreciation, I'd be inclined to go that route.

[Carl]

From what i see in Turbo Tax, you cannot take something out of service for personal use without saying it was sold... seems to be a flaw.

No flaw, and you can take a property out of service by converting it to personal use, and you will not be asked for sales information. Read the "Special Handling Required?" screen. When you select YES on that screen, you will not be asked for sales information.

Still baffled on how to do this the correct way in Turbo Tax and now there is another option or method to consider.

That's because since you did not take care of this on the 2017 tax return originally, you can't do it correctly on your 2020 tax return without filing the IRS 3115 - Change in Accounting Method form. Even then, since the program includes practically no help or guidance for that form (because it's not simple) attempting to do it yourself without knowing what you're doing is a sure fire way of begging the IRS to audit you. (Maybe they will, maybe they won't.)

If this was the 2017 tax return you're working on, you simply remove the original entry from service effective on the date of passing. Then  enter the original asset a 2nd time using half the values on the initial entry and all the original dates. Then delete that original entry you converted to personal use. That effectively "wipes out" 50% of the depreciation.

Then you enter another asset using the stepped up basis applicable (50% of the stepped up values) with the in service date being the date of their passing. Once that's done,  there would only be two entries left concerning the property in the Assets/Depreciation section. One entry using half the values with the original in service date, which would "wipe out" the deceased persons half of the depreciation, and the new entry with the stepped up basis of the deceased' 50% using an in service date of their date of passing so that depreciation would start on that stepped up basis on their date of passing.

Unfortunately, that wasn't done on the 2017 return, which means the 2018 and 2019 returns are wrong. Therefore, the 3115 is the only viable way to fix things and correctly report the sale.

[TurbUser102x]

Thanks Carl you answered my question very well with your explanation on the assests - which is what I was looking to confirm based upon my own understanding in Turbo Tax.  As for correcting,  I'm amending 2018 and 2019 returns this week to fix the errors. 2017 I have to throw in the towel because it's too late.  But the date of death was basically at the end of the year, so I'm only forfeiting the last month of 2017 for any depreciation that could have been taken on, and for 18 I will just use the first of year and put a note in for explanation (or something to that effect).

By the way, I looked into the 3115 form and talked to several CPAs on this, including a few tax experts on rentals, and they all said not to do that form and simply to amend the returns I can and correct from there.  Not saying you are wrong by any means, and likely there is more than one way to "skin a cat", but the folks I talked to on this basically said that the 3115 wasn't required and to just amend and correct the returns I could.

Thanks again

[Carl]

I understand why you're not amending the 2017 return. With a passing date in December of 2017, I'd probably not amend that one either. The "savings" would not be worth it.

I'm amending 2018 and 2019 returns this week to fix the errors.

Be aware of what that means, because you've got your work cut out for you. When you amend the 2018 tax return, that means your imported data in the 2019 tax return will be wrong. You can't import from a prior year, when you amend a return. So you'll have to manually figure the correct numbers for the 2019 return (namely prior year's depreciation and carry over losses if any) and change the numbers that were originally imported from the 2017 return.  You'll have to do exactly the same for the 2018 return since it's originally imported numbers will be even further off.

Once you get the 2019 return amended, then you can start your 2020 tax return over from scratch and make sure you import from the amended 2019 return, and not from the original. (This matters big time if you originally filed the 2018 and/or 2019 returns using the online version of the program.)

As a reminder, a prior year tax return or prior year amended tax return can not be e-filed. (The IRS says so). You have to print, sign and mail the returns. If a state return is involved, that gets amended too and mailed to a physically separate address from the federal return. Additionally, each tax year gets mailed in a physically separate envelope.

Make sure you write down the 2019 AGI from the "originally" filed 2019 tax return. You will need that AGI in order to e-file your 2020 tax return. Since amended returns are processed by hand it can take anywhere from 12-16 weeks for it to be processed. So there's no way the "new" AGI on the amended 2019 tax return will be processed before you e-file the 2020 tax return. Therefore, you'll have to use the original 2019 AGI in order to e-file the 2020 tax return.

I also recommend you mail the 2018 amended return first. Then wait about a week to mail the amended 2019 tax return. Otherwise, if the IRS starts processing your amended 2019 tax return before the 2018 return, they "will" find what will be interpreted as major problems which will result in an "audit by mail".  You've got enough headaches to deal with now. So don't be in such a hurry to create even more.

Finally, I do recall having read in some IRS Pub that for situations like yours, when you've not depreciated for 2 or more years, or have incorrectly depreciated for 2 or more years, amending isn't an option and the 3115 is required. For the life of me I can't find the IRS pub that says that. So either my memory on what I read is skewed (very possible) or I"m just not looking in the right place. This is just a "heads up" in case you get feedback about this from the IRS with your amended returns.

[tagteam]

---

@TurbUser102x wrote:

.....the folks I talked to on this basically said that the 3115 wasn't required and to just amend and correct the returns I could.

---

The folks you talked to are wrong.

See https://www.irs.gov/publications/p946#en_US_2020_publink1000107385

[TurbUser102x]

Thanks for the follow up.  Ironically enough, I'm in this predicament because a CPA "tax expert" at Turbo Tax in 2018 told me that there was NO stepped up basis because the property did not "change hands" when a spouse died.  I recall this, and guess what, when I called again this week, someone, likely the same person, said the exact same thing to the person on the phone who relayed it to me.  I corrected them, and then on a second call follow up they admitted they were wrong.  So bad advice from a so called "expert" screwed me over the first time around.  Now I'm paying the price to fix it big time.  Wish I had never messed with Turbo Tax in the first place.