How to handle depreciation when the cost basis changed when the property was sold

[lizab1]

I purchased a primary residence in 1988 and paid $112,500. There were substantial repairs and remodeling done while living there, but I did not keep track of them. I converted it to a rental property in April 2000. At the time I entered the purchase price of $112,500 and allocated 12% ($13,500) to the land. I have used TT throughout the entire rental process. I sold the property in April 2021 for $442,000. I have now realized that I should have entered the FMV of the property when I started renting it. I went back to the property appraiser's records and found the value for the year 2000 to be $262,020. My thought process was this would be legit with the IRS since I didn't know how much I spent on remodeling/repairs. I allocated 12% of that amount for the land. When I researched on here how to enter the corrected cost basis an expert replied to this question and indicated to enter the adjusted cost basis and leave the prior depreciation blank and TT would calculate what should have been claimed. (I realize this is a loss to me since I didn't take it over the years.) When I did that TT shows a depreciation of $9,982 on Schedule E (along with my other expenses). Prior to making the changes I made a note of the depreciation for each prior year which was $3,318. An additional note was made, prior to changing the cost basis, of the prior depreciation on form 4562 which was $77,430.  After making the changes form 4562 (D&A Report) shows only the $9,982. When I entered the sales information (and split out the improvements and land) TT only shows the $9,982 for the depreciation being added back in (form 4797 part III). Does the rest of the depreciation not apply? If it does, how do I correct it? Thank you! 

[Carl]

I purchased a primary residence in 1988 and paid $112,500. I have now realized that I should have entered the FMV of the property when I started renting it.

For the property itself,you use the "LOWER" of what you paid for it, or it's FMV at the time of conversion. Since $112,500 was the "LESSER" amount, you did that correctly.

There were substantial repairs and remodeling done while living there, but I did not keep track of them.

There is a defined difference between "repairs" and "remodel". Remodeling is more commonly referred to as "renovation costs".

I converted it to a rental property in April 2000. At the time I entered the purchase price of $112,500 and allocated 12% ($13,500) to the land. I have used TT throughout the entire rental process. I sold the property in April 2021 for $442,000.

That's to bad unfortunately. Renovation costs incurred before the property was converted to a rental should have been added to the cost basis of the structure at the time of conversion.  Renovations done after the property was converted to a rental are added as their own asset entry and depreciated over time. Since you did not do that, You can either report the sale using your original cost basis as entered, or you can add the assets now, and you are required to recapture and pay taxes on the depreciation you "should" have taken, but did not.

Other than that, professional help would be called for. Especially if you don't have the means to prove what you paid for your property improvements.  (Proof would only be needed if you were audited on this)

[lizab1]

or you can add the assets now, and you are required to recapture and pay taxes on the depreciation you "should" have taken, but did not.

Thank you. If I add the assets now how do I recapture the depreciation? 

[Carl]

The program takes care of depreciation recapture "for you".  Enter the asset with it's original in service date. If that date is prior to 2021, one of the screens will "assume" you took the required depreciation and will show you that amount. Don't change it, and just continue on.

Then when you report the sale, that depreciation will be recaptured and taxed.

Note that you need to work through the "Sale of Assets/Depreication" seciton first, for the sole purpose of entering your assets. Then you will work it through a 2nd time for the purpose of reporting the sale.

Reporting the Sale of Rental Property

If you qualify for the "lived in 2 of last 5 years" capital gains exclusion, then when prompted you WILL indicate that this sale DOES INCLUDE the sale of your main home. For AD MIL personnel who don't qualify because of PCS orders, select this option anyway, because you "MIGHT" qualify for at last a partial exclusion.

Start working through Rental & Royalty Income (SCH E) "AS IF" you did not sell the property. One of the screens near the start will have a selection on it for "I sold or otherwise disposed of this property in  2021". Select it. After you select the "I sold or otherwise disposed of this property in 2021" you continue working it through "as if" you still own it. When you come to the summary screen you will enter all of your rental income and expenses, even if it's zero. Then you MUST work through the "Sale of Property/Depreciation" section. You must work through each individual asset one at a time to report its disposition (in your case, all your rental assets were sold).

Understand that if more than the property itself is listed in your assets list, then you need to allocate your sales price across all of your assets.  You will only allocate the structure sales price; you will NOT allocate the land sales price, since the land is not a depreciable asset.  Then if you sold this rental at a gain, you must show a gain on all assets, even if that gain is $1 on some assets. Likewise, if you sold at a loss then you must show a loss on all assets, even if that loss is $1 on some assets.

Basically, when working through an asset you select the option for "I stopped using this asset in 2021" and go from there. Note that you MUST do this for EACH AND EVERY asset listed.

When you finish working through everything listed in the assets section, if you ever at any time you owned this rental you claimed vehicle expenses, then you must also work through the vehicle section and show the disposition of the vehicle. Most likely, your vehicle disposition will be "removed for personal use", as I seriously doubt you sold your vehicle as a part of this rental sale.