Should I change the depreciation value of an inherited house turned rental property since the county finally reassessed the taxes?

[jbarthur]

In 2015 my siblings and I inherited a house in CA.  It’s property tax was 40% land/ 60% additions at time of death.  In 2016, I bought out my siblings and began using it as a rental, the ownership changed to my name and the house was reappraised.  There was no property tax reassessment done yet (county government speed) so I used the 60% of the new appraised value to determine the depreciation basis for two years of my tax filing. The property tax was eventually reassessed, but now is about 60% land/ 40% additions.  The 60% I used vs the county update of 40% is about $4200 a year difference in depreciation. So… do I need to adjust my depreciation since I was using percentages from 25 years ago before the county finally got around to reassessing? Is either keeping the depreciation I had or changing it to the new county assessed numbers a problem with IRS or recapture later? Thanks!

[pk]

As I understand the situation -- (a) You and your siblings inherited  the property in 2015;  (b ) on the date of death  or soon thereafter, of the decedent an appraisal was performed; (c) in 2016 you bought out your siblings, transferred the title to yourself and proceeded to use the property as income/ rental property; (d) you started a depreciation schedule based on the county assessment   (with 40% land, 60% improvement); (e) subsequently county has updated assessment ( and with 60% land and 40% for improvements ).  So the question now is which split should you use.

The basis of the property at the time of transfer to the inheritors was the basis at death of the decedent.  You basis in the property at acquisition is your own share of the original basis ( 1/x  of the at death appraisal) + what you paid to acquire the property from your siblings.  Any subsequent appraisal changes  by the county has no effect on your basis.  Similarly, if the original split between land and improvements was 40/60 and you have started depreciation schedule base on that, without approval by IRS, you cannot change that. Depreciation continues the same way -- clearly you would like a higher depreciable basis and IRS would also love that because there is more gain at the end to be treated as ordinary gain -- not capital gain.

Please also note that if the at transfer value of the property was higher than at death appraisal, there is gain for each of the inheritors that needs to be taxed.

If you need more on this. please feel welcome to put your question in comment

[jbarthur]

Thank you. This info is helpful. You have the situation grasped well, but just to clarify... The 40 land/60 improvement percentage was my parents' property tax they had for 25 years.  This was not a new assessed tax value after death as I never received any property tax reassessment (inherited exclusion I assume). Even after I acquired the full property, I did not receive a new tax assessment from the county for over a year. I initially had nothing else to go by for my starting basis, so I applied the old 60% improvement to the new value of $560k = $336k.  The county reassessment was triggered because of my change in ownership, but received after I'd filed previous tax returns. The new county land/ improvements for my ownership went to 60/40% respectively, thus making 40% of the $560 now $224k.

I understand my 1/3 of death appraisal combined with the amount I paid my siblings, the higher basis benefits, and your point of my depreciation normally continue as is.  But the way I started the basis was with the limited info I had at the time.
 
Since the county’s reassessment was the result of my new ownership (even though it took so long), and the fact I’m depreciating $112k more than the county says it’s worth, is this an issue I need to address?  

Will depreciation recapture eventually happen the same regardless of these discrepancies and therefore I shouldn’t worry about it?  

I didn’t know if there was any cross-checking by the IRS on these values or issues if the wrong basis was used... be it unintentional.
Thanks again!

[pk]

Higher land value  means that your depreciation per year goes down but preserves your basis at disposition better -- yes ?
Since you are concerned that your depreciable basis is probably wrong ( if you use the county assessment ) AND because you have used the old depreciation only for only 2016 and 2017 ( i.e. within the statute of limitation ), there are two paths as I see it ( and without requiring IRS approval/ permission):
(a) proceed with as is -- no change. Generally IRS has little interest in verifying the  depreciable basis. Unless you become randomly selected  for a full audit for compliance.  Very unlikely, unless you are very unlucky and even then you have a good logic why you continued plus IRS always loves ( or should love ) higher depreciation  because of increased ordinary gain.
(b) change to the new  split for 2018, amend the 2016 and 2017 returns  ---- reason being land value change going back to 2016 by the county.

I think that either way is as good as another  even though  as a landlord looking at longer term effects, I would prefer to have less recapture amount when I ultimately sell the property or would like to use the property as main residence for two years before I sell so that I can exclude the gain  ( even though the recapture  may still haunt me  ).

Good Luck