depreciation and capital gains

[cmoy]

I am wondering if I did my depreciation calculation correctly throughout these years?  So in 2005, my wife bought a condo for 375K.  We used a 27 year straight-line depreciation for all these years, $13,888 each year.  However, I suspect I did things wrong.  She passed away in 2015, and went to an estate account because it went into probate.  Furthermore, I did not get awarded the house again until 2020.  Should the depreciation accumulated have been reset back to 0 at some point, either in 2015 or also in 2020 because of a step up situation?  Also, I'll assume that the depreciation amount should have been adjusted to whatever the new market/assessed value starting in either 2015 or 2020?

Obviously the answer to this question affects the capital gains calculation. 

If the depreciation accumulation does go back to 0 say in 2015 and/or 2020, how do I go about filing an amended return(s)?

[Mike9241]

since you say your spouse bought th property, I assume you had no ownership interest in it. in that case, the tax basis to start for computing gain or loss is the date of death (2015) fair market value. probate is irrelevant .prior depreciation disappears. then if the property was again rented, depreciation should have started anew depending on the use of the property after her death. see a tax pro. this is not a situation you should try to handle yourself. 

[tagteam]

Was the house tied up in probate for circa five years? If so, was it rented during that time?

As @Mike9241 suggested, you really should consult a local tax professional.

If the house was in the estate post-mortem and rented, depreciation would start over (a new 27.5 year recovery period) at the property's fair market value as of the date of death (i.e., that would be the basis for depreciation). In that event, the estate would almost certainly have been required to file a 1041.

[cmoy]

it was rented out the whole time.

[tagteam]

---

@cmoy wrote:

it was rented out the whole time.

---

Exactly and, so, how were the income and expenses being reported for that circa five-year period?

[cmoy]

income and expenses for the period in 2015 after death, 2016, 2017, 2018 and 2019 were all done on a separate estate account.  Unfortunately, I not only carried over the accumulated depreciation from before 2015, I also carried the accumulated depreciation after the house went back into my possession for my 2020 and 2021 taxes.

[Opus 17]

It's also important to know if you are in a community property state or not.

Also, your depreciation is probably wrong from square one.  Land never depreciates, you only depreciate the cost of the buildings and other things attached to the land.  If this "condo" includes shared ownership of land, common areas, and so on, that should have been accounted for.

I believe, that if you truly had no ownership interest, and you fully inherited the property in 2015, then you received a stepped up basis equal to the FMV on the date of the previous owner's death.  You should have reset the depreciation to year one at the 2015 FMV (minus the FMV of the land).  I also believe you were the inheritor as of 2015, even though the paperwork didn't clear until 2020.  However, if the estate reported the rental income on form 1041 (the estate tax return), then your basis might only reset when you were awarded the deed in 2020.  It really is a situation that requires an attorney and an accountant.

If your spouse calculated the depreciation wrong starting in 2005, and you filed joint returns, you are jointly liable for that misstatement.  However, the statute of limitations has run out for most past years.  

You're asking about capital gains so did you sell?  You are correct, your basis reset to FMV in either 2015 or 2020 and you should have reset the depreciation to the new basis and started a new 27.5 year clock.  The capital gains and depreciation recapture if you sold or are planning to sell is based on the depreciation you should have claimed, not the depreciation you actually claimed.  To correct prior incorrect depreciation, you will file form 3115 rather than filing amended returns.  You will also need an accountant to prepare form 3115 for you, it's not a layperson level form and it is not supported by Turbotax. 

[cmoy]

thanks for the info!  A somewhat random CPA that I talked to today a few min ago pretty much mentioned all the same things. 

I really never thought about this, until the place got sold and I realized that depreciation reduces the cost basis, and very significantly since I've been depreciating it for the last 18 years  Since I am doing a 1031 exchange, I'm not sure how much of this matters with regards to the sale of the condo, but our other property, yeah I definitely need to fix that since the FMV went up a signficant amount.  

I've never had anyone do my taxes before, it's been TurboTax for the the past 30+ years.  How do I find a good one that can deal with this situation?  (San Jose area).

[tagteam]

Your basis will not "reset" merely because the property was in probate and the estate was reporting rental income and expenses on its 1041. You will wind up with a carryover basis (of sorts) from the estate, meaning you will succeed to the basis the estate took (which was the fair market value on the date of death).

Also, Form 3115 is designed to adjust depreciation due to an impermissible method of accounting and not mathematical or posting errors, the main issue typically being the scenario where depreciation deductions were never taken. Merely calculating the wrong amount of depreciation is not a scenario that can be corrected by filing Form 3115 (as it is not an impermissible method of accounting).

If you are looking for a local tax professional, you can start with the site below.

Tax experts in SAN JOSE | Find an Enrolled Agent Near You | Find a Tax Professional (naea.org)