Can I correct an incorrect cost basis for a rental property when it is sold? Does IRS allow the change?

[tester74]

Hello,

I had entered an incorrect purchase price for a rental home (converted from primary residence, 355k instead of 365k). Last year, I sold the price and now I see that having 355k as cost basis increases my tax. Turbo tax allows me to change the price I paid for the home, does IRS accept the cost basis to be changed now? What is the correct procedure to deal with this mistake? Any insights greatly appreciated.

Thanks,

[JamesG1]

If only two or three years are in error, you may amend the tax returns for each year, reporting the reduction in depreciation expense.  Then the current year’s tax return would be reporting the correct cost basis.

But tax returns more than three years old may not be amended and refunds will not be honored.

IRS form 3115 Application for change in accounting method can report the change but this form is not supported by the TurboTax software.  See the instructions here.

[AmeliesUncle]

Yes, you can just change it to the correct amount.

However, with the higher Basis, when it asks for "prior depreciation" you need to be sure you enter the amount that you SHOULD have claimed (based on $365,000).

When you converted it from personal use to a rental, you should have entered the LOWER of (1) your Adjusted Cost Basis at that time or (2) the Fair Market Value on the date it was converted to a rental.  Which of those two was lower, and is that the amount that you used?

[DavidD66]

You can file Form 3115, Application for Change in Accounting Method.  This will allow you to make a retroactive change to your depreciation expense on your 2019 tax return due to the incorrect cost basis.  Otherwise, you will be paying depreciation recapture tax on the depreciation you were entitled to take, which will be greater than actual depreciation claimed.  Form 3115 is not available in TurboTax.

[AmeliesUncle]

No, Form 3115 does not apply.  Using  an incorrect Basis is a "mathematical or posting error", which does NOT qualify for Form 3115.

If the OP wants to get the slightly higher depreciation for the last 3 years, they can amend those returns.  But Form 3115 can not be used.

[Carl]

@tester74 all of the responses given thus far are wrong. Here's what you do in "YOUR" specific case and "ONLY" in "YOUR" specific case.

Basically, you will report the sale in the "Sale of Business Property" section.

First, work through the Rental & Royalty Income (SCH E) section of the program. for this property select the option for "I sold or otherwise disposed of this property in 2019" and then continue working it through.

Enter any and all rental income and expenses as normal.

Now in the "Sale of Assets/Depreciation" section  you *MUST* work through each individual asset listed, one at a time. As you work it through, write down the prior years depreciation and current year's depreciation on each individual asset.

 - Select the option for "I stopped using this asset in 2019"

 - On the "Special Handling Require?" screen select YES (If you select NO you will be *FORCED* to enter sales information, and we're not reporting the sale here.)

 - You must do the above for each individual asset listed, one asset at a time.

When done with everything in the "Sale of Assets/Depreciation" section, continue working through the rest of the SCH E.

If you have claimed *ANY* vehicle use at *ANY* time during your ownership of this property, then work through the Vehicle Expenses section to show that you stopped using the vehicle in 2019 and removed it for personal use. (I seriously doubt you sold the vehicle as a part of the rental property sale.)

Once you've worked through the SCH E in it's entirety, you're done with that section. Now to report the sale.

Elect to start/update "Sale of Business Property"

Select "Sale of business or rental property you haven't already reported" and continue.

Since you sold the property at a gain, select YES.

Now you can enter a description of the rental property you sold, date you purchased/acquired it, date you closed on the sale, the sale price, the "correct" cost, and then total up all of your depreciation numbers you wrote down earlier and enter that total in the last box.

Now press on with life and finish working it through. Easy-Peasy.

[AmeliesUncle]

@Carl   The OP still needs to claim the correct depreciation this year.  In order to do that, the amount needs to be changed in the "asset" section.  Because that is corrected, it can correctly be reported in the "asset" section rather than the "Sale of Business Property" section.  While it could be claimed in the "Sale of Business Property" section, there is no indication that it would need to be done that way.

But the OP NEEDS to calculate and use the "prior depreciation" that SHOULD have been claimed using the correct higher Basis (if you leave that entry BLANK, the program will automatically use the proper amount).  That is need in order to claim the correct current year depreciation, as well as to calculate the correct amount of gain.

[Carl]

This is absolutely no different than if the FMV of the property at the time it was placed in service, was less than the original purchase price. It's how you can significantly reduce your chances of an audit while still reporting the sale with the correct information and only paying taxes on what you should be taxed on.

Besides, the other way (that may increase chances of an audit) is to add the $10K difference to the value of the land and leave the value of the structure alone. That makes all prior as well as the current year's depreciation alone.

You go changing the structure value on the SCH E and that's basically screaming for an audit, whereas increasing the land value only is yelling softly for an audit. Reporting it my way in "Sale of Business Property" doesn't even so much as raise an eyebrow. But "if" audited (and I doubt that would happen) they have the paperwork to prove their cost basis.

[AmeliesUncle]

Claiming the proper amount of depreciation on Schedule E certainly won't attract an audit.  It is simply reporting it correctly.  By knowingly continuing to claim the incorrect amount of depreciation, you are filing an incorrect tax return.

[Anonymous]

righto and the Taxpayer has to use the depreciation that would have been allowed.  

[westenterprisesinc]

How can I correct my cost basis for a rental property I have sold in 2019? I built the home in 2008 and I never caught this until now. The cost was 200K for land and $249K for building. I have $79K in loss carryforwards because my income was higher than $150K each year. 

My cost basis is $100k too low - yikes

[Virginia_PropTax]

@CarlI am having a similar issue wherein I have a rental property that I sold in 2019.  This was a personal property that I converted to business/investment in 2013 when it was worth less than when I purchased it in 2005.   At that time I calculated a FMV, allocated to Land & Building, and depreciated accordingly, all in Turbo Tax.  Now, I am trying to record the sale.  In my case, I have neither a gain (calculated based on my original cost basis + improvements less depreciation) nor a loss (calculated based on my FMV at time of conversion less depreciation). 

In the Rentals section, the FMV is shown and used to calculate a sales "gain".  When I follow the instructions for special handling under "Sale of Business Property" and update the cost basis to my regular basis from the original purchase, TurboTax gives me an error that I "do not have a gain" and removes/deletes my entry.  It then maintains the "gain" based on the calculation using the FMV that it carry's over from the Rental Income section.  I have read all the IRS rules for calculating loss/gain, and I believe that in my circumstances, I have neither a loss nor a gain.  But, how do I correctly, enter this info into Turbo Tax? 

[Carl]

As I understand it, using the original purchase price you have a loss

Using the lower FMV at time of conversion you have a gain.

Therefore

I have seen this before and always recommended professional help. The bottom line is, the TurboTax program *can* *not* *correctly* handle this situation no matter what you do. I've tried different scenarios myself last year with TTX 2018 and could not get a correct result. But if someone figures it out, it sure would be helpful to let folks in this forum (such as myself) know.

One thing I've never gotten clarity on is for someone with your specific scenario, where you have a gain with one cost basis, and a loss with another. The best information I can find on which cost basis to use is in IRS Publication 551 page 11 at https://www.irs.gov/pub/irs-pdf/p551.pdf. But it doesn't cover what we need it to cover.  So the best information I can give you, is "seek professional help". You've got two days before the filing deadline. If you will be getting a refund, there will be no penalties for filing late. But if you owe the IRS, you "will" pay interest on what you owe if you pay after July 15th.

[Virginia_PropTax]

@Carl  Thank you for taking the time to respond and validate my conclusion that TurboTax isn't addressing my situation accurately.  I will file an extension and look for help.

[mishelk]

Hi All-

I have a similar situation and appreciate support.  I placed my residence into rental service in 2011, at the time the preparer recorded the value of the structure too low by 80k.  Is it worth it to correct this year?  I do notice with the higher value i get a larger depreciation ...just not sure if i need to fill a form out.  From reading this thread i'm under the impression i can change it this year, but did not understand the consideration of adjusting the depreciation for prior years.  Any help is appreciated.