How do I establish a cost basis for a rental property? I claimed a refinance deduction in 2014. Do I use information from 2014 or current information?

[barfiear]

I moved to this property in June 2016.  I converted the garage into an apartment for my personal use, repaired the upstairs living area (fully funtional two bedroom home) and continue to rent the upstairs.  We share the utility costs.  My personal portion of the total living space is 40% and the upstairs is 60%.  I plan to continue this indefinitely.  I have appropriated all the expenses into three main groups; rental maintainence/repair for upstairs, conversion of space (Residental Rental Real Estate), and shared expenses including taxes, utilities, insurance, ect.  For the last group of shared, I have taken the first six months of expense as rental, and for the second half, applied the 60/40% split and then added the rental together.  Does that make sense and is it legal?

[Carl]

The cost basis for determining depreciation is the **LESSER*** of
A) It's FMV at the time the property was placed in service
B) What you paid for it, plus the cost of any property improvements you paid for.

99% of the time, item B is the lesser.

[barfiear]

Land and house were a gift given over many years (all documented).  Began renting it in 2014 when I refinanced due to divorce, but didn't get the basis in at that time.  Do I need to re-file for 2014 and 2015?  Seems I way over paid on taxes.

[TaxGuyBill]

If you received it as a Gift, you received the giver's Basis.  You need to find that out.

Are you saying you did not claim depreciation for 2014 and 2015?  If so, that needs to be corrected by the long, complicated Form 3115.  TurboTax does not support that, so I would recommend going to a tax professional that is experienced with catching up on depreciation using Form 3115.

[barfiear]

I filed for an extension for 2016, knowing this would be complicated.  Can I go ahead and file my 2016 final return and then deal with the Form 3115 before the end of the year?  Will that also refund any overpayments to me?

[TaxGuyBill]

No, Form 3115 must be filed with your timely filed, original tax return.  In other words, it needs to be filed WITH you 2016 tax return.

Sort of.  Form 3115 will 'catch up' on the missed depreciation by adding it to your 2016 tax return.  So it will effectively give you a larger 2016 refund (or less owed).

[barfiear]

Ok.  So I have until Oct. 16th to get it done and postmarked.  The accountant will need all federal and state returns, and basis.  Since I had it for years before renting it, is it better to use tax assessment or fair market value?

[TaxGuyBill]

???  You said you moved in to it in June 2016 and implied it was rented since 2014.  Now you say you had it for years before renting it.  What was the property used for before it was rented, and for how long?

As Carl said, you depreciate the LOWER of the Adjusted Basis and the Fair Market Value.  That means you need to first find out the Adjusted Basis of the person who gave you the property.

[Carl]

" is it better to use tax assessment or fair market value?"
No, you can't do that. Your cost basis is the *LESSER* of what you paid for it, or the FMV at the time it was placed in service as a rental. Since this was gifted to you and you assume the giver's cost basis, there is no question that what the giver of the gift paid for it, is the lesser. The IRS specifically states that you can not use the tax assessment value, except under extreme circumstances. Your circumstances are not even anywhere close to extreme.

[barfiear]

I was given the property by my mother next door and built a "vacation" house.  CO obtained in 2002.  Began renting it in Nov. 2013 to cover expenses and refinanced in 2014.  I have been renting continuously since then except for one month between tenants.  Moved to this town in June 2016 to settle and take care of my Mom (Alzheimers).  Converted garage into small apartment for myself with small shop area.  So now I rent and live in it.

[barfiear]

So basis will be what the property value was when gifted plus what I spent to build the house, correct?  And thank you for your help.

[Carl]

No. The basis is what the person who gifted it to you, paid for it. Doesn't matter if they purchased the property 50 years before they gifted it to you. It's what your mother paid for it. (Assuming your mom gifted it to you). You can get that figure at the county courthouse in the property tax section. They'll have a history of all property transfers (including the transfer of the property to you from your mom) and the price paid by the buyer to the seller. Some counties have that information on line. so check your county tax assessor's website.
"plus what I spent to build the house"
Wait a minute. YOu said earlier the house was gifted to you. Now you say you built it. What's the scoop here and what's going on?  Before you answer, give me a minute to provide you some information that I'm sure will help you to clarify things. I have to provide this in an answer box, vs a comment box, because I can't highlight things in a comment box.

[TaxGuyBill]

For example, let's say your mother bought her house with all of the land for $100,000.  Let's say the land valuation is 20% of the total purchase (as Carl said, the property tax assessor often will indicate the ratio).

So the total purchase price of all of the land was $20,000.  Then if your mother gave you exactly half of the land, your 'cost' would be $10,000 (assuming both lots of land were of similar value).

Yes, you then add the cost of building the house to the cost of the land.  That is your "Cost Basis".  Once you have that, then you can determine which is lower, your Cost Basis or the Fair Market Value when you started to rent it.

[barfiear]

My lack of approriate terminology is certainly confusing, but I promise I am just trying to get this right.  The land itself that was gifted to me over several years was inherited by my mother from my father, from his mother before, and his grandmother before that.  My mother had consulted professionals who structured the land gift.  The building of the house was a collaborative effort, with permits in my name.
I have read through the info you kindly sent.    Improvements I made in the conversion include plumbing changes, electrical changes (sub-panel and wiring), installed small kitchen, washer/dryer hook-ups, wall partions, replace garage door with windows, HVAC split unit.  These were not "start-up" costs but were necessary for me to have a place to live.  Still, they are part of the house overall and increase the value of the house.  BTY, I will NEVER sell this place.  Gave up a LOT to keep it in the divorce.

[Carl]

All those things you listed above are without question, property improvements and add to your original cost basis. Just out of curiosity, what is the total cost of all the property improvements you did? Also, in what year was the house built? (This will hopefully, help me to help you determine cost basis).
In what city/state/town/township/etc is the property located?