Stepped-up basis and depreciation on Community rental property in California on death of spouse. Both H & W filing MFJ as California Residents.

[Wish2]

I have the following questions on stepped-up basis and depreciation on Community rental property in California on death of spouse. Both H & W filing MFJ as California Residents.

• Husband died in March 2023. For 2023 MFJ tax return, how should the surviving wife report the stepped-up basis of the rental prop held in both H & W names as community property? Does she report 100% fair market value as of the date of death on the 2023 tax returns?
• On form 4562, how is the stepped-up basis reported and the Depreciation calculated? Is it calculated from March 2023 to Dec 2023 based on the FMV or is it calculated for the full 2023 year on FMV over the 27.5 years asset life?
• Where to note on form 4562 that the depreciation is now on a stepped-up basis?
• What will happen to the depreciation deducted in prior years when H was alive?
• The wife sold the rental property in May 2024. How will she recapture the depreciation in 2024 that she would have taken in 2023 on the stepped-up FMV basis?

[tagteam]

I am sorry for your loss.

Your basis would be stepped up to the full fair market value of the property as of the date your husband passed (March 2023).

Prior depreciation (accumulated up to March 2023) simply disappears and you are the successor to the property in severalty (i.e., the sole owner) with, again, your basis being the fair market value on the date of passing in 2023.

[tagteam]

If you're filing a MFJ return for 2023, then you would report income, expenses, and depreciation as you have on prior returns up to the date of death.

At that point, you would indicate that the property was "converted to personal use" (or a similar disposition without a sale) so that depreciation would stop on the community property.

Thereafter, you would create a new asset with the depreciable basis being the full fair market value in March 0f 2023 and being depreciation on that asset using a new 27.5-year recovery period.

[tagteam]

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@Wish2 wrote:

The wife sold the rental property in May 2024. How will she recapture the depreciation in 2024 that she would have taken in 2023 on the stepped-up FMV basis?

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Depreciation deductions allowed or allowable will be calculated from March of 2023 (date of death) through the date of the sale (May 2024) for the purposes of depreciation recapture. 

[Wish2]

Thank you for your prompt response.

The FMV on the date of death in March 2023 was high but when the rental R/E was sold in May 2024, it was sold at a much lower price than the March 2023 FMV. 

After H's death, can the surviving wife carry over the big loss on the sale of rental R/E to future years? If so, for how many years?

[tagteam]

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@Wish2 wrote:

The FMV on the date of death in March 2023 was high but when the rental R/E was sold in May 2024, it was sold at a much lower price than the March 2023 FMV. 

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How much lower? Note that depreciation deductions from March 2023 through May 2024 (the date of the sale) will reduce the basis (which was the FMV in March of 2023).

[tagteam]

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@Wish2 wrote:

After H's death, can the surviving wife carry over the big loss on the sale of rental R/E to future years? If so, for how many years?

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If there is, indeed, a net loss on the sale, it could be used to offset all other types of income in 2024 and could even generate an NOL. 

[Wish2]

Thank you for your prompt response.

For proper reporting on form 1040 of 2023, how is the Stepped-up basis of the rental R/E on the date of death reported on what forms to avoid questions from the IRS? 

On what form do I indicate that the Rental R/E was "disposed of without a sale"?

Do I then create a new form 4562 Depr showing the Stepped-up basis and the date placed in service as of the date of husband's death?

How to split the land and building value on the new Depr form? 

[tagteam]

Are you using TurboTax or any other income tax preparation program?

You simply need to stop depreciation on the date of death and then add the new asset (solely owned by W) thereafter. 

The land and building values would be split in accordance with the appraisal (or other indication of value) on the date of death.

The asset would be listed on Form 4562 because it is essentially a "new" asset.

[Wish2]

Where and how on Form 4562 do I indicate that the property was "converted to personal use" (or a similar disposition without a sale)?

To take out the rental R/E from form 4562, the tax program requires to enter a lot of information in the Disposition Section such as Date of Disposition, Sale Price, Expenses of Sale, Type of Prop (if Sec 1245/1250 prop), gain/loss etc.

I do not understand how I can show that the property was "converted to personal use" (or a similar disposition without a sale) and let the tax program take it out from Form 4562.

I would appreciate your help in this matter. Thank you

[tagteam]

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@Wish2 wrote:

Where and how on Form 4562 do I indicate that the property was "converted to personal use" (or a similar disposition without a sale)?

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In the Rentals section of the program, click the Start or Update button to the right of Property Profile.

[tagteam]

In the Assets/Depreciation section, check the box shown in the screenshot below.