Gain or loss on the sale of a rental property

[lg79]

We bought our house in 2010.  In 2012 we had to move out of state for work and have rented it ever since.  We sold it September 2020.  The sale price was only $9k more than we bought it for and we had roughly $30k in closing costs and expenses at the end of the sale.  Turbo Tax is calculating that we have a $54k taxable gain on the sale.  This is after we are recognizing a loss on the rental income this year. That doesn't seem right.  What did I do wrong?

[Carl]

During the period of time the property was a rental, you were required by law to depreciate it. Basically, depreciation lowers your cost basis. In the year you sell the property you are required to recapture all depreciation and pay taxes on it. So it sounds to me like you took the depreciation as required, and then recaptured it as required. Thus, you have a taxable gain; not a loss.

Since you lived in the house as your primary residence (I assume) for at least two of the last five years you owned it, you qualify for the capital gains tax exclusion. Meaning you don't pay taxes on the gain up to $250K if filing single, or $500K if filing joint. However, recaptured depreciation gets taxed "no" "matter" "what", as it's not included as part of the excluded gain.

[Mike9241]

the gain should not exceed the depreciation allowable which is about 3.636% per 12 months. for depreciation purposes you use the lower of cost or fair market value on the date converted to rental. then from that you must reduce that number by the value of the land based on which of the two amounts you used for depreciation purposes.

[Hal_Al]

Deleted

[lg79]

Thanks.  SO here is my follow up.  Obviously I dropped the ball by not claiming depreciation over the last 8 years.  Not sure why Turbo tax never prompted me to, but that's another issue.  Now that we've sold the house, should I go back and file a 3115 for change of accounting method and file amended returns for as far back as allowed? Is it worth the time, effort, and accounting fees to reduce my rental income? Looking back over my previous tax returns, by claiming depreciation we would have had a loss every year.

[Hal_Al]

Sorry, I misread your original post and though you had a gain. I’ve deleted my answer.

With closing costs, you have a loss.  You must recapture the depreciation whether you claimed it or not.  What I'm not sure of is whether you can reduce that recapture by a prorated portion of the capital loss.

You now say “I dropped the ball by not claiming depreciation over the last 8 years.” But earlier you said you starting renting it in 2018, which would only indicate 2 to 3 years of deprecation.  You don’t depreciate for the time it was your residence.

I’m not an accountant and am not familiar with the rules for form 3115.  But, my gut feeling is that you can amend, to claim deprecation, going back 3 years, without that form.

[Carl]

But, my gut feeling is that you can amend, to claim deprecation, going back 3 years, without that form.

If you used TurboTax for 2018 and 2019, then there's a good possibility that you did take depreciation and don't realize it. If (and that's a big *IF*) you did everything correctly per the guidance the program provided you, then the program will take care of depreciation stuff in the background and generally not bother you with the details. So you need to check your 2018 and 2019 tax returns. Chances are, if you did things right, you did "in fact" depreciate the property those two years and don't even realize it. Otherwise....

At this point in time you can amend back to 2017. You only need to go back to 2018 since you started renting in 2018. However, understand that this will require a "LOT" of manual work on your part.

 - A prior year tax return can not be e-filed. This includes a prior year amended tax return. (IRS rules currently state this as of the date of my post here.)

Additionally, you "must" use the desktop version of TTX 2018 and 2019 to amend those two years.

Additionally, since you can not import information from a prior year tax return when you amend, you will have to print out the 2018 completed return and manually enter the "correct" depreciation numbers for "prior year depreciation" on your 2019 return, when you amend the 2019 return.

Then after you do all that, you will be able to import from your 2019 amended return, into your 2020 tax return if you complete the amending process "BEFORE" you start your 2020 tax return. It's a bit tricky to import from the amended tax file on your desktop computer, but it's perfectly doable.

[tagteam]

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@lg79 wrote:

.....should I go back and file a 3115 for change of accounting method and file amended returns for as far back as allowed?

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You do not file amended returns; you only file Form 3115 for which professional guidance is recommended.

Once you file returns for two consecutive tax years without deducting depreciation, you cannot amend those prior returns; you used an impermissible accounting method that can only be corrected by filing Form 3115.

Adoption of accounting method defined.

Generally, you adopt a method of accounting for depreciation by using a permissible method of determining depreciation when you file your first tax return, or by using the same impermissible method of determining depreciation in two or more consecutively filed tax returns.

See https://www.irs.gov/publications/p946#en_US_2019_publink1000107385