Rental Property Cost Basis Sale

[Giants25]

Hi,

I sold my rental property on 8/17/2020 but from 2013 to 2015 it was my personal property and I made improvements to the home.  However, when I first started renting the house in mid-2015 I used the original purchase price (370K) as the cost basis.  During 2013 to mid-2015 (before renting) I did approximately $35K worth of improvements but again these were not added onto to the cost basis of the rental - I used the purchase price.

Fast forward to 8/17/2020 and I sell the rental property for $560K.  The tenants moved out in mid-May and I spent approximately $30K or so to fix up the home to ready it for sale.  How do I add the improvements I made prior to renting the home and the improvements I made pre-sale to increase my cost basis and reduce the amount of tax that is due?  I cannot find any place to simple add these values without Turbotax wanting to take depreciation deductions - which it should not since it was never part of the cost basis.  I believe I should be able to increase the cost basis with these improvements and thus reduce my tax obligation.

Thank you.

[DavidD66]

The only way to correct the omission of your improvements and add them to you cost basis, is to file Form 3115 - Application for Change in Accounting Method.  I suggest you file an amended return for 2019 with Form 3115, to add the improvements as assets, and take all the prior year depreciation you were entitled to for those assets.  After filing  the 2019 amended return, you will the correct amount of cost basis and depreciation with which to calculate the gain on the sale of your rental.

If you don't retroactively add the assets and take the prior years' depreciation, you will not only have a lower cost basis than what it should be, you will also have to calculate depreciation recapture tax on the depreciation you were "entitled to" but did not take.

TurboTax does not support Form 3115, so I suggest you seek out the services of a local CPA or EA in your area to help you with the amended return.

[Carl]

During 2013 to mid-2015 (before renting) I did approximately $35K worth of improvements but again these were not added onto to the cost basis of the rental - I used the purchase price.

Unfortunately, that is a mistake that you can not correct yourself. It's not as simple as one may think. You need professional help for this in order to know it's fixed correctly. While TurboTax does include the 3115 you need to file in order to fix this, your situation is not a simple one by any stretch. Please seek professional help to get this done correctly so it doesn't come back to bite you. The cost of professional help will seem like a pittance in comparison to the fines and penalties the IRS will assess if things are not done right.

[Giants25]

Hi,

So it sounds like there is not a way to have improvements made prior to renting my home factor into the basis of my home I sold?  And any improvements I made prior to selling and after the tenants moved out cannot be used to adjust my cost basis?  I honestly thought any improvements would be used to adjust my tax basis when I sold my home but based on the below that is not feasible.  I have to file form 3115 and essentially adjust the amount of depreciation taken annually?  Why wouldn't I just add it as an asset to the Sale of Asset/Depreciation section.  Any additional thoughts would be appreciated.

Thank you.

[M-MTax]

After the last renter moved out you can add the cost of improvements to your basis but cannot deduct rental expenses because the property was not rented or available. You need to file a 3115 with your 2020 return.....you don't amend your 2019 return for this.....and you will get a wash since the foregone depreciation deductions will be recovered while your basis will be lowered to the same extent. Get a tax pro no matter what.

[Carl]

So it sounds like there is not a way to have improvements made prior to renting my home factor into the basis of my home I sold?

Sure you can. However, you did not depreciate those improvements that were done prior to renting the property, as required by law. That's the problem, and that's what you need to fix. Failure to do so will at some time in the future come back to bite you. After you've sold the property and reported the sale, the last thing you want is that ghost popping up a few years after when you "think" that property is done and gone from any cencerns you may have with it.

[Giants25]

Hi Carl,

I want to make sure I understand your below statement.  As it pertains to any capital improvements made prior to me renting the home, the only way to adjust my basis is to have those costs be depreciated over the years the home was rented? 

In addition, because I sold the house on 8/17/2020 and after the tenants moved out any improvements I made to the house also cannot be added to the basis of the home?  Or if you can, how do you get that done?

And thank you for your time in answering my questions.

[M-MTax]

As it pertains to any capital improvements made prior to me renting the home, the only way to adjust my basis is to have those costs be depreciated over the years the home was rented? 

Right and you use the 3115 for that which would be filed with your return for the current tax year.....3115 lets you catch up on all of the depreciation you missed over the years.

In addition, because I sold the house on 8/17/2020 and after the tenants moved out any improvements I made to the house also cannot be added to the basis of the home?

Add those improvements to your basis.....add their cost to your adjusted basis and put that total in turbotax as your basis.

[Critter-3]

In the year of sale ... the 30K you spent in fixing up expenses is added to the Sch E as repairs ... they are NOT added to the basis or depreciated.  

[Carl]

the 30K you spent in fixing up expenses is added to the Sch E as repairs ... they are NOT added to the basis or depreciated.

That works, and it only applies to the $30K spent "AFTER" the last renter moved out, and before you closed on the sale.  You can do this, because you don't have to take into account any depreciation "only" on that $30K since the property was never placed in service again, after those specific improvements were done.

But the 3115 is still required for the improvements you did before the property was a rental, since you failed to depreciate those specific improvements.

[M-MTax]

Yeah, if they're FIX UP expenses you CAN'T add them to your basis. BUT if they're IMPROVEMENTS you CAN add them to your basis. Hard to figure someone spent $30k getting a house ready for sale.

[Giants25]

As I mentioned up front, all of the costs are improvements and thus both can be added to the basis - per the CPA I spoke with.

$30k is actually pretty easy and fast to get to after renting a home for a few years, not sure if you have done many home remodels and upgrades.

Here are a few sample costs:

New flooring - $3K

New HVAC - $10K

Paint all interior, replace baseboards & paint - $10K

Landscaping and tree removal - $3K

[M-MTax]

Yeah $30k is easy but not with fixing and small repair costs.....you have improvements that you made that can be added to your basis.....maybe not painting costs though.

[Critter-3]

Once again ... any fixing up expenses in the year of sale  are entered on the Sch E as repairs ... they are not added to the basis or depreciated.  

[Giants25]

Thank you but there is a difference between fix up expenses and capital improvements.  These were capital improvements which can and should be used against the basis.  I am not sure why everyone is so fixated on expensing capital improvements, especially when the improvements were made when the property was my personal property - it was not generating rental income.  In addition, I am not looking to depreciate these improvements since they were not incurred while I was generating rental income.  Thank you everyone!