Depreciation of an improvement that changed ownership percentage on a joint-owned rental property

[jasonrust]

I have a rental property co-owned with a brother. I have had a depreciation schedule for the building based on my ownership percentage when it was purchased. A fire on the property necessitated a near rebuild of the property. Insurance covered all but $100k of the repair costs. The other family member paid the extra $100k in exchange for an increase in his ownership percentage.  Two questions:

Can I keep my existing depreciation for the original property and treat the $100k as an improvement that only he needs to add as a new asset with its own depreciation schedule? 

Does the fact that the insurance repairs resulted in an almost-new building mean I should change my depreciation basis for the building asset in TurboTax?

[RobertB4444 · Accepted solution]

This actually results in a fairly complicated math problem so buckle up, @jasonrust.  

Technically, when the old building burned down the new rebuild becomes a new asset.  So you need to sell the old asset at a loss (received $0 in the sale) and create a new asset.  The creation of the new asset is the weird part.

You need to add up the cost of the land from the original asset (the non-depreciable portion of the asset) plus the cost of the rebuild (which includes the portion of the rebuild paid for by the insurance) plus the accumulated depreciation from the original asset (how much you had depreciated the building up until the fire).  The total of these is the new asset with an put-in-service date of the date of the completion of construction.

Also, keep in mind that any rent that was paid by the insurance company is income for the year in which it was paid and should be entered as such.

Here's some more information and an example.

[jasonrust]

Thanks, that's very helpful. I looked at the link you included and one thing I want to confirm that the depreciation taken thus far should be added to the cost of the land.   This was the math used in the example:

What I paid for the rebuild -------------------------------$150,000
Amount allocated to land ORIGINALLY -------------- $30,000
Amount of depreciation already taken prior to fire- $25,500
TOTAL -------------------------------------------------------$205,500  (This is the amount to be entered in the COST box)
For COST OF LAND box, you take the original cost for that and add the depreciation already taken to it. So using my numbers above the COST OF LAND box will have $55,500 entered in it

Is it correct to deduct the depreciation from the COST, but add it to the COST OF LAND? It seems doing so would just cancel out the depreciation already taken.

Once this new asset is entered, I can then adjust the numbers based on the new percentage that I own, correct?

[jasonrust]

Also, should I check the box that says "I sold or disposed of this property in 2021" or just delete the asset?

[ColeenD3]

 Two points:

1) The depreciation does not increase the basis, it lowers it. You have already had a tax advantage from taking it, so at the time of sale, it will give you a larger gain. Also, land is not depreciated. All the depreciation belongs to the building.

2) As @RobertB4444 stated, "So you need to sell the old asset at a loss (received $0 in the sale). So you need to keep the asset in the program to show the sale. Do not delete it now.

[Carl]

Since this is with your brother, are you reporting the rental income/expenses on a 1065 Partnership return?

Technically, when the old building burned down the new rebuild becomes a new asset. So you need to sell the old asset at a loss (received $0 in the sale)

Disagree. There was an insurance payout.  The old structure was sold to the insurance company for the amount of the payout. I expect it would still be sold at a loss after that, but it accounts for the payout for what that payout was really for.

Keep in mind that the land was not insured. Only the structure. So you still own the land and the cost basis of the land does not change, as the land was not sold to anyone.  So dealing with this in TTX is going to be complicated.

The new structure cost basis is the amount of the insurance payout, plus whatever was paid out of pocket.

Being that

[jasonrust]

@Carl We co-own it as business partners, not as a LLC, and so each file the rental expenses/income via Schedule E rather than a 1065 and K-1.

[Carl]

Just an FYI, but the 1065 is used for both multi-member LLCs and Partnerships.

With a partnership, you don't necessarily have to use the 1065, it does make things a bit easier and simpler on the tax front when you have assets that are not all split 50/50 on the ownership front.

[Carl]

I see so much conflicting and incorrect information in this thread, I don't know where to begin.

So you need to sell the old asset at a loss (received $0 in the sale)

No so.

Insurance covered all but $100k of the repair costs.

Your sales price of the old asset is whatever the insurance payout was. On top of that, you did not sell the land, and the value of the land did not change. Only the structure was sold.  Add to that, one partner paid $100,000 to cover the costs of rebuilding that was not covered by insurance.

Now I could keep going and dig a really deep hole here, that even I can't get out of. I would highly recommend that both of you seek professional help. If your state also taxes personal income then professional help is even more highly recommended here.  The cost of professional help will be a pittance, when compared to the quagmire you can get yourselves into with the IRS as well as the state, if not done right.

I also recommend that going forward, you establish a partnership and starting reporting this on the 1065 Multi-member LLC/Partnership return. Especially since ownership share is not split evenly now between the partners.