How to Handle Depreciation Change

[DR116]

I have owned a 2-unit rental property for 15 years. The first 10 years I lived in the building and was depreciating half of the purchase price over 27.5 years (because half was investment property). After 10 years I moved out and began renting the whole building. I continued depreciating that same amount though for the next 5 years, so may have been under depreciating it. I have a couple of questions:

• At 10 years, when I moved out, should I have taken the book value (purchase price minus depreciated amount) and depreciated this over the remaining depreciation period (27.5 years from the purchase date)?
• Now that I have continued to depreciate the lower amount that was calculated in the beginning, can I calculate a new book value and now depreciate this value over the remaining depreciation period (27.5 years from the purchase date)?

[DianeW777]

The answers appear below each question.

• At 10 years, when I moved out, should I have taken the book value (purchase price minus depreciated amount) and depreciated this over the remaining depreciation period (27.5 years from the purchase date)?
  • When you moved out, and the personal portion became rental property, you would use the original cost, capital improvements and then split that in half.  Add a new asset for the newly rented portion of your duplex.  Also add any assets that were actually put into this converted section if applicable. The depreciation would considered the first year for this converted section of the duplex and begin the 27.5 year recovery. Purchase date should remain the actual date and the first day it became available for rent is the day you converted it from personal to rental.
• Now that I have continued to depreciate the lower amount that was calculated in the beginning, can I calculate a new book value and now depreciate this value over the remaining depreciation period (27.5 years from the purchase date)?
  • Yes, half the original cost as noted in the response to your first question.

Note: When a property is converted from personal use to rental use, the actual amount that is allowed for depreciation is the lower of cost or fair market value (FMV).  In general the value would increase over time, for this reason I advised to use the actual and original cost, plus cost of improvements.  It will be the easiest and most clear down the road to enter two rentals, your first duplex and then the one you converted.  It will be much more simple for historical purposes and for a future sale.

[DR116]

Thank you very much for the quick response. This is very helpful.

[DR116]

I wanted to ask a follow-up question to this related to the 2-unit building and depreciation. Knowing that the depreciation was calculated incorrectly, how can this be corrected? The information I have is the initial purchase price, the purchase date, the date I moved out (this is when a new asset should have been created) and how much has been depreciated on the entire place so far (all depreciation has been calculated starting on the purchase date). It sounds like I may need to set up two assets: one for one unit when the building was purchased and one for the 2nd unit (starting when I moved out) but how do I account for what as already been depreciated? I actually have this same issue for other associated assets like a new roof and other improvements and I am assuming I'd treat these in a similar manner.

[DianeW777]

The original answer assumes you did use half the purchase price as indicated for the first part of the duplex when it began to be rented 15 years ago. For the depreciation that was not used for the five year period after your converted the second duplex, you can take all of that as an expense in 2024.  This was unclear in your original question.  Here is the answer and information to capture it now.

For the five year period where you inadvertently missed the depreciation for the second duplex you began to rent, set the asset up as though you had taken it. Use the original date you began to rent it as the date placed in service. You do not use a new book value.  Write down the number for 'prior depreciation' when that screen comes up.

Next, for the prior depreciation you have not used.  

• You can use the following form to correct the depreciation for your rental property. Take any amount not previously expensed on prior returns, as an expense on the current year tax return as 'Other Expenses'.

Form 3115 Instruction: By including this with the current year tax return, you can complete everything on the 2024 tax return.

• Adopt a change in accounting method: This option allows you to go back as far as you need. Make the adjustment on your current year tax return to expense the missing depreciation.
  • Why am I adopting a change in accounting method? Not claiming depreciation in two or more years indicates that you've chosen an accounting method without depreciation. In this case, you must now elect to change your accounting method to include depreciation.
• You must use the TurboTax Desktop ‌ to complete this form. TurboTax doesn't help you with this form. And your return must be mailed because this form is not supported through e-file.

This must be completed and filed with the return on time.

You can change to TurboTax Desktop if you choose.

• How to switch from TurboTax Online to TurboTax Desktop?

[AmeliesUncle]

It seems like you have used Do-It-Yourself software (such as TurboTax) to file incorrect tax returns for the last five years.  Do you really want to continue to use Do-It-Yourself software?

I highly recommend going to a good tax professional this year to correct the problems that using Do-It-Yourself software (such as TurboTax) caused.

[DR116]

Unfortunately, in this case, exactly the opposite is true. I had been seeing a tax professional (two different professionals over the years) and it was Turbotax that clued me in to the issue.