Rental property - entered in incorrect cost basis a few years ago and thus have an incorrect depreciation for a few years ... what to do?

[raynam8]

Dear Community:

I was hoping you can help me.  3 years ago, I started using Turbotax and at that time, I entered in the basis for my existing rental property incorrectly and thus, for the last three years, I have been depreciating more than I should have. 

What should I do? 

Option A: I could do a 1040x for each of the three years but this seems so complex. 

Option B: Can I just correct the basis this year, taking into account the TOTAL depreciation thus far I have expensed including the incorrect amounts these three years and just move forward?

My preference is Option B.  It would mean that for three years past, I should have paid more taxes (I had a higher depreciation expense) but it also means that in the outyears, I will now have a lower depreciation expense than I would have if I did not make the mistake since the basis will be lower.

Any help is appreciated.  Thank you! Ray 

[ColeenD3]

 Using a wrong Basis for depreciation can only be corrected by amended returns, and you can only amend up to the 3 prior years. 

When entering the asset in TurboTax and it asks for "prior depreciation", you need to enter the amount that you could have taken (if you leave it blank, I think it automatically calculates that).

Depreciation errors are corrected by either filing an amended return or filing a change in accounting method form. Depreciation errors that are NOT subject to the accounting method change filing requirements require amended returns and include:

Amended Returns:

• You claimed the incorrect amount because of a mathematical error made in any year.
• You claimed the incorrect amount because of a posting error made in any year.
• You claimed the incorrect amount on property placed in service by you in tax years ending before the statute of limitations has expired.
• You are changing the amount of Section 179 claimed or not claimed.
• Election to apply the $2,500/$5,000 de minimis safe harbor rules (within its own time period requirements of return due date plus extension).
• Election not to claim bonus depreciation under 168k (within its own time period requirements of return due date plus extension).

Amending returns will only correct depreciation errors that have occurred in the last three years.

Wrong basis

[Carl]

You'll need to amend each individual return, starting with the oldest one first.  Take note that when you amend the 2nd year, you will have to enter prior year's depreciation manually, as when amending you can not import from the prior year return. So to get the correct amount of prior year's depreciation, that's why you have to start amending the oldest tax return first.

[raynam8]

Thank you for the response.

I made an error in depreciation for 2018, 2019, 2020.  Does this mean I can amend those three years?  I heard about form 3115 being needed if a change needs to be made prior to 3 years.  I then hear about the "2 year rule".  I am confused as to when the 3 years back start.  Essentially, I did it incorrectly for 3 years straight and was wondering if I need form 3115 or it is just a simple amendment?

Thank you.

"The use of an incorrect method of depreciation, which would include taking no depreciation, is considered the use of an incorrect accounting method. Once an incorrect accounting method has been used for two years, a Form 3115 is required to change accounting methods back to a correct method, or in this case, since not taking depreciation is incorrect, to begin taking depreciation a Change in Method Form 3115 must be filed." 

[raynam8]

I made an error in depreciation for 2018, 2019, 2020.  Does this mean I can amend those three years?  I heard about form 3115 being needed if a change needs to be made prior to 3 years.  I then hear about the "2 year rule".  I am confused as to when the 3 years back start.  Essentially, I did it incorrectly for 3 years straight and was wondering if I need form 3115 or it is just a simple amendment?

Thank you.

[ColeenD3]

You are not correcting an incorrect depreciation method, you are correcting your basis. 

Explanation of the 2-year rule:

The use of an incorrect method of depreciation, which would include taking no depreciation, is considered the use of an incorrect accounting method. Once an incorrect accounting method has been used for two years, a Form 3115 is required to change accounting methods back to a correct method, or in this case, since not taking depreciation is incorrect, to begin taking depreciation a Change in Method form must be filed.

Outlined in my earlier post, the IRS states:

Depreciation errors that are NOT subject to the accounting method change filing requirements require amended returns and include:

Amended Returns:

• You claimed the incorrect amount because of a mathematical error made in any year.
• You claimed the incorrect amount because of a posting error made in any year.
• You claimed the incorrect amount on property placed in service by you in tax years ending before the statute of limitations has expired.

[raynam8]

Thank you for the response and sorry for me not truly understanding it.

For 2018 to 2020, I entered in an incorrect cost basis which then triggered an incorrect depreciation expense for those three years.  Note:  I owned this property since 2009 and just made this error in 2018 to 2020.  I thought that IRS treated incorrect depreciation for more than two years as a change to depreciation method requiring form 3115.  

[raynam8]

I will also add that a sold it (well replaced it in a 1031 exchange) in 2021 so not sure if there is something I could do in 2021 to fix everything other than amending 2018 to 2020 (if possible).

[tagteam]

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@raynam8 wrote:

I thought that IRS treated incorrect depreciation for more than two years as a change to depreciation method requiring form 3115.  

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Not exactly. Using the incorrect basis for depreciation is not a change in the method of accounting for depreciation.

See https://www.irs.gov/publications/p946#en_US_2020_publink1000107385

[Corren12]

Hi, I have a similar question.  I used the wrong cost basis for my rental property from 2015 through 2021 (included my land value resulting in a  higher cost basis, therefore a higher depreciation each year).   Do I address this issue by amending prior 3 years' returns by adjusting the "Rental Properties and Royalties (Sch E)" section by manually entering the correct cost basis, prior depreciation, etc starting with 2019, then 2020 and finally 2021?  

Thank you for your guidance

[ColeenD3]

You will have to amend from 2015. The three-year limit applies to being able to get a refund for incorrect amounts. You will have to start at the beginning and work your way forward. 

[raynam8]

OK, thank you.

[pjblouin]

In my situation, I did enter the Building value only (no land value) in the original cost basis for depreciation.  So looks like this was correct on my part. 

But now, I just sold the rental and turbotax is calculating the gain based on final sales price minus the (building-only) cost basis, that's not correct!

what am I doing wrong?

Thanks

[Carl]

In my situation, I did enter the Building value only (no land value) in the original cost basis for depreciation. So looks like this was correct on my part.

How is that correct? Do you not own any portion of the land the building is on? (and uncommon possibility if you own a unit in a high-rise condo building). The amount in the COST box is the amount you paid "in total" for the property. The amount in the COST OF LAND box is whatever portion of the amount in the COST box, that you allocated to the land.

SO are you saying that the amount you entered in the COST box was not the total price you paid for the entire property, but the cost you allocated to the building only? If so, this is fixable and easily fixed on your 2021 return without needing to amend anything, since land is not a depreciated asset. All I need is the value for the building that you entered in the COST box, along with the value of the land, and we can go from there. THose two values added together, should add up to the total price you paid for the property.

[pjblouin]

I do own the land where the bldg sits.

I only entered the the value of the building. Not the value of the land.

Cost basis (bldg) entered = 150K (entered in TurboTax - been depreciating on this value every year)

Actual Purchase price = 289K (in 2013)

by deduction, cost of Land = 139K

Where do we go from here?

Thanks for the help.