Depreciation on Rental Property

[SRI64]

I am filing for the first time.  I have owned rental property, but it was not earning enough to be taxed as it is my only income besides Social Security.  Therefore, I have never taken the depreciation from prior years that the property was in service.  When TT prompts me to review the prior years' accumulated depreciation, can I reduce that to zero and will it carry that forward?  I tried it and it did decrease my taxes further, but I wanted to confirm that this is the right way of doing such.  I understand that I will pay on depreciation recapture at the sale of the property, so I want to make sure I actually take advantage of it.  Thank you for your help.

[Critter-3]

OMG !!!!

RUN to a local tax pro to get the depreciation issue fixed ... it is a requirement NOT an option.  

[SRI64]

I understand, but can I carry forward the unused depreciation on TT by stating 0 has been used in prior years? There is an area that allows you to change the accumulated figure. It is showing approximately $5000 for 3 years. However, since there was no tax liability I didn't file.

Is it necessary for only an accountant to handle this?

[Critter-3]

NO ... the only way to fix this gross error is by filing a form 3115 which is not for the DIY user.   

Adding depreciation would give you a negative Sch E and the un allowed loss will be carried forward until you sell the property or have a positive income on the Sch E.  This is the normal way to complete a return... choosing to omit the depreciation deduction  or use it only in the years you choose is not allowed.  

[DawnC]

You are required to take the depreciation deduction.   Even if you did not take depreciation, you have to recapture the full amount of the depreciation you should have taken, so that can become quite costly.   You can't carry forward the unused depreciation and you don't want to change those numbers for this year's tax return.  

Since you have missed claiming the depreciation for multiple years now, the best option for you is to file Form 3115 - Application for change in Accounting Method.  This option would allow you to claim depreciation for all the years you have missed.  Filing form 3115 is a delicate process and I would advise to hire a local tax professional to do it for you.

[Posted Edited 01/21/21 6:13 PM]

[SRI64]

Thank you that was very informative. And, it would be wrong to just file for 2020 and moving forward without using the depreciation from prior years?

[Rick19744 · Accepted solution]

The information provided by @DawnC regarding amending your tax returns is incorrect.

You have established a method of accounting by not depreciating it.  While this is incorrect, it is still a method.

A method of accounting is established if you have filed more than one return with the incorrect method.

You will need to meet with a tax professional who can help provide guidance on completing the Form 3115.  Doing this will assure that you can take advantage of missed depreciation.

I would recommend meeting with one soon before they get too busy.

[SRI64]

Thanks so much. I'll be off to the accountant. But, if I don't file form 3115 for missed depreciation won't the $5000 I missed amount to roughly $1250 which is the 25% tax on recaptured depreciation when I sell?

[Critter-3]

Ok ... you are missing an important point ... if your income is so low you cannot deduct the depreciation then when you sell the property the unused deduction goes on the Sch E in full  which will automatically balance off the recapture amount so you pay NOTHING in taxes ... right now you have a $1250 mistake to fix.  If you don't fix it on the 2020 return the error becomes more costly each passing tax year.  Have the tax pro explain it to you ... that is what you are paying them for.  

[SRI64]

Thank you for your time and help!

[Carl]

I have owned rental property, but it was not earning enough to be taxed as it is my only income besides Social Security.

A few things that need to be clarified a bit more.

 - You are required by federal law to depreciate rental property. It's not an option.

 - It is *NOT* common for residential rental real estate to show a taxable profit *ON* *PAPER* when you file your tax return. It is more common for residential rental real estate to show a loss *on* *paper* every single year, when you file your taxes.  Particularly if there's a mortgage on the property.

When you add up your allowed deductions of mortgage interest, property taxes, insurance, and the depreciation you are required to take by law, the total of those deductions will usually exceed the total rental income for the tax year. Add to those deductions the other allowed rental expenses (repairs, maintenance, utilities, etc) and you're practically guaranteed that your rental losses will exceed your rental income every single year. (Of course, for every rule there are exceptions.)

Once your rental losses/expenses gets your taxable rental income to zero, that's it. You can't deduct any more. The excess loss gets carried forward to the next year, where you can deduct them *IF* you have sufficient taxable rental income to deduct them from. That almost never happens. Therefore, you carry over losses will continue to carry forward and grow larger with each passing year.

You can't "realize" your unused carry forward losses until the year you sell the rental property. In the year you sell, your losses are first deducted from any taxable gain realized on the sale. If that gets your taxable gain to zero and you still have more losses left over, then the remaining losses can be deducted from other ordinary income, such as W-2 income up to a maximum of $3000 a year (depending on your *EARNED* income) until those losses are all used up.

it is my only income besides Social Security.

So with no other "EARNED" income, that means you will never be able to take advantage of any excess losses. However, your heirs will be able to after you pass, if you have willed them the property in your will. That's because your heirs will get a step-up in basis based on the FMV of the property on the date of your passing. That will "basically" cancel out all those carry forward losses in their favor.

[SRI64]

Thank you for that!  I understand.  However, as all situations are specific....my rental properties cost $42,000-$89,000.  There is no mortgage.  I have no losses.  This year I will owe taxes even after all expenses. ??? That is why I am now filing.  Not having known about the depreciation bit and that I should have just filed before even with a few dollars in losses in prior years.

Is that different?

[SRI64]

Amend that, I've never shown a loss. But, with no income other than SS and rental income of $12, 000 nothing was owed.

[Carl]

I've never shown a loss. But, with no income other than SS and rental income of $12, 000 nothing was owed.

If more than $12K (even by one dollar) then you're required to file (assuming a filing status of single).

I'm not sure on this ( @Hal_Al can clarify) but since rental property is considered a business, if you have more than $400 of business income then you are required to report it. I question this requirement on rental property because it's not "earned" income.

But even if not required to file and you don't file, it does not negate your requirement to take depreciation for every year the rental property is in service.

Example:

- Property placed in service on Jan 1, 2017

- You were not required to file at ax return for 2017, 2018 and 2019

- Due to increased income, you *are* required to file a tax return for 2020

In this case, you must account for 3 years of prior depreciation. The program will figure this for you automatically. No 3115 would be necessary or required since you had not filed the prior 3 years anyway.

[Hal_Al]

I believe the $12,000 ($12,400 for 2020) gross income  filing requirement includes actual total rents received and not just you net profit from rentals. You would still not owe any tax, as taxable income would still be zero.  Most rental situations are not "business" and would not be subject to the self employment filing requirement.

I agree with Carl,  "even if not required to file and you don't file, it does not negate your requirement to take (account for)  depreciation for every year the rental property is in service".  In his example, you must account for 3 years of prior depreciation. The TurboTax  (TT) software will figure this for you automatically. "No form 3115 would be necessary or required since you had not filed the prior 3 years anyway".  

When you start entering your assets (usually just the house), TT will ask you when you placed it in service.  It will then calculate the depreciation allowed for all the previous years and continue that deprecation schedule  for the current tear (2020).  

When TT prompts you to review the prior years' accumulated depreciation, you do NOT reduce that to zero. And, yes will it carry current and past depreciation forward.