Rental Property Depreciation - Missed in 2021 & Incorrect cost basis in 2022 Tax filing

[anxsa]

Hi All,

  Bought home in 2019 however put it as a rental only in 2021. My tax consultant didn't take any depreciation deduction for FY-21 and when I filed for FY-22 on my own, I took an incorrect cost basis (used 80% land instead of 60%, so took less depreciation deduction than intended). 

My question would be what recourse is there to move forward and do it the right way. I am not an expert in Tax by any means so if it makes sense to not go into too much hassle and rather just eat up the previous year's loss and just correct in FY-23 return, I could do that. However if IRS strongly feels about these numbers being reported right then of course I would love to follow the suggested approach.

[DianeW777 · Accepted solution]

It depends on how you want to handle it.  

First and foremost you need to make sure that 2023 is correct.  Keep in mind that and is always appreciable so for this reason it can never be depreciated. Be sure it is separated out correctly (you can use the city/county tax assessments or a method you believe is accurate).

Next, you have two choices for the prior depreciation you have not used.  The IRS tax law states allowed or allowable which simply put they considered it used or lost.  At the point of sale you will recapture any depreciation that was allowed or allowable.  It's a use it or lose it situation.

1. Amend your 2021 and 2022 tax returns to accurately utilize the allowed depreciation for those years; OR
2. You can use the following form to correct the depreciation for your rental property, take any amount not previously expensed on a prior return, 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 2023 tax return.

1. 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.
2. You must use the TurboTax CD/Download version to complete this form. TurboTax does not 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 CD/Download if you choose.

• How to switch from TurboTax Online to TurboTax CD/Download?

Amended Returns:

For tax years 2022, 2021, or 2020 - How do I file my 2022, 2021 or 2020 Tax Return? 

To file a new prior-year return, you'll need to purchase and download that year's TurboTax software for PC or Mac, as TurboTax Online and the mobile app are only available for the current tax year. (Note: Returns for tax years 2019 and earlier are no longer eligible to be filed through TurboTax.)

Prior-year returns must be paper-filed, as e-filing is no longer available for them. We'll walk you through that process when you get to the File section in the software.

After installing the software, open it and follow the onscreen instructions to file your return.

Here are some other resources that might help:

• Accessing a prior-year return
• Amending a prior-year return
• Finding last year’s adjusted gross income (AGI)

[anxsa]

Thanks @DianeW777  for such a detailed and prompt answer, very helpful!

Looks like your recommendation is to just correct everything with 2023 tax return and that way there would be no need to worry about amending FY21 and FY22 returns. If this is not right, please correct me.

Based on your suggestion I have a couple of questions:

1. I read on forums that apart from mailing (not e-filing) the FY23 tax return with 3115 form, there is also a need to fax or send a copy of 3115 form to another IRS address. Is that still needed?  
2. As per below quote, I would just like to clarify that though I didn't claim any depreciation on FY-21, but I did claim it on FY-22 (which was also not using correct cost basis though). Does this still qualifies me to do Form 5113 change and do a change in accounting method?

---

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.

[DianeW777]

Yes, you should also fax a copy per the instructions.

Yes, you do qualify to utilize the Form 3115 because the accounting of the asset and the depreciation is not correct on the original return or the second year. This requires a change in accounting method for your asset. Basically you are correcting the depreciation to what you were allowed the first and second year.

[anxsa]

Thanks again @DianeW777 !