Sale of Rental Property / Depreciation / Losses

[aamedia]

I sold a rental property in 2021 that was converted from a main home in 2012. Until this year, I never claimed depreciation. Every year was a loss since tenant rent did not cover mortgage and other expenses.  My available loss deducation that accumulated was calculated to be over $104,000.  The house was purchased on 2005 for $367,663 and land value was $78,000. The home sold for $380,000, but commissions were $22,800 and there were many sales expenses. The amount that went to me and the mortagae pay off was $357,200, which is $10,463 less than what I paid for the home. And that doesn't account for the sale expenses lost.

Now comes depreciation. Under the Sale of Property / Depreciation, I indicated that the home was sold, gave the requested information and it calulated that I could have claimed $92,603 in prior years and $10,094 this year. I'm not being asked for a sales price here and I've read a lot of conflicting posts on that. The botton line is that when I follow any of the several suggestions regarding how to input the sales information, because of this depreciation recaputure, I go from a refund of nearly $14K to owing nearly $14K.

What's going on here? This property has costs me a ton of money and I did not make a profit on the sale. Tubo says I'm entitiled to $104K in losses now that the home is sold. What am I doing wrong here? Do I owe $14K or am I due $14K? I know about Form 3115 to claim the prior depreciations, but that's even more confusing that my current predicament. So before going there, is there anything in what I'm saying about that is a hint of something I might be able to easily correct?

[DanP0428]

Sadly, deprecation must be paid back when you see a rental property even if you never claimed it.  It is a good lesson for others to claim their depreciaton every year.

[KrisD15]

"I sold a rental property in 2021 that was converted from a main home in 2012. Until this year, I never claimed depreciation. "

Unfortunately this is a problem. 

The IRS does not necessarily demand you claim depreciation yearly HOWEVER the IRS does demand you "recapture" the depreciation whether you claimed it or not. 

How did you report the rental each year? What did you report as the basis for the rental on your Schedule E? 

The basis would have been the Fair Market Value at the time you switched from personal to rental or what you originally paid, whichever was lower. 

"Now comes depreciation. Under the Sale of Property / Depreciation, I indicated that the home was sold, gave the requested information and it calulated that I could have claimed $92,603 in prior years and $10,094 this year. I'm not being asked for a sales price here and I've read a lot of conflicting posts on that."

True, the program first needs to know what has happened with the rental up until the sale before it can compute the sale itself. 

Rentals are depreciated over 27.5 years. It was a rental for almost 10 years. If the basis of the rental was 367,663 (it could have been something else since you don't say what the fair Market Value was) about 104,000 depreciation sounds right. 

So the adjusted basis would be about 366,000 - 104,000 = 262,000

If you received about 358,000, that would be a recapture of about 96,000. 

Once the rental is listed, you need to go to the asset list of that property to report the sale. 

Go back into the rental section, and review.  Click EDIT by the property, then scroll down to "Sale of Property / Depreciation"

Yes, you could have carried over the rental loss year after year and applied that loss when you sold the rental, did you do that? 

This is something that would have needed to be reported each year so that the IRS can trace it. 

@aamedia

[aamedia]

Hi Kris,

I've carried over the years of loss and will claim them. I had not been claiming the depreciation since I've never noticed anything that even mentioned listing the home as an business asset once it became a rental and Turbtax never found errors. We're not borning knowning these things.

All of the numbers I gave are after I've already entered the "Sale of Property / Depreciation" information and reported the sale. I'm confused on where to report the actually selling price because there doesn't appear to be a way to do that in this section.  As mentioned, different people have reported different things. Some people said to do it under "Sale of Business Property" and that seems incorrect if I'm already reporting sale in this section.  Others said to say "no" to "special handling" in the "Sale of Property / Depreciation" section and go with the "Home Sale". But according to what I see under "special handling",  you should check "yes" on rentals.  So I checked yes and it tells me the depreciation deduction for 2021 will be transferred to the correct form. But now where do I report the selling price?

What's the correct answer here for me to be able to add the selling price for the home so it can figure this out properly. If I say yes to special handling and I'm not asked for the selling price, the totals of my federal and state refund us about $13,900. If I try to add the selling price by following what some people have said about listing under "Sale of Business Property", now I owe a fortune and the same thing happens if I say no to special handling and try adding the selling price there. When I run the review, all of these options say there are no errors$%$@!? Which road am I supposed to be taking? 

Turbotax has already calculated my loss, but has it been applied already or is that going to factor in later once this is straight?

@KrisD15 

[ColeenD3]

This is not something you can just continue with as if not taking depreciation is not a big deal. Yes, you are going to have to pay a lot of money on any gain and the depreciation recapture. Part of the problem is that your depreciation should have been based on the lower of the FMV or the adjusted basis on the date you placed it in service. You need to correct this and the only way to do it is to file a Form 3115. Since you are forced to recapture the depreciation you never took, you need a way to also claim it.

Tuesday, January 18, 2022

12:16 PM

Unfortunately the depreciation recapture is "allowed or allowable" meaning even if you never depreciated it, you would still have to recapture the depreciation. Depreciation taken would be on line 18 of Schedule E.

One solution is to elect an accounting method change and file a Form 3115 in the current year and take the  prior depreciation as a section 481(a) adjustment. [land  value is separated, land is not depreciated]

Below are the IRS links related to the change in accounting method. TurboTax does not have that form.

May be these will help

Form 3115, Application for Change in Accounting Method

Change-in-Accounting-Method

Instructions for Form 3115 (03/2012) 

Instructions

Form 3115,

Form 3115

[aamedia]

Thanks, Colleen.

I figured there would be a problem. I was wondering what needs to be cleared up in case the 3115 was necessary. TurboTax is misleading to those of us who are not tax professionals in that it does not explain this complication in advance. It would be better if it did force us list a rental home as an asset and depreciate rather than have us find out ten years later while passing all of those returns as "correct".  Had it made things clear, I would have seen a tax pro ten years ago instead of going to fix this problem. Paying money isn't a problem since it's going to come out of what we got from the home sale. I just want to make sure this is done right. 

My wife purchased this home not long before the crash and it went way underwater. After we got married and she moved in with me, it was converted into a rental while still underwater. That being the case, I'm assuming the FMV was probably below her purchase price. Currently, I don't know what that would have been so this is more complicated than I'm going to be able to handle alone.  I'll chalk up paying for TurboTax desktop as another loss and make an appointment for in-person consultation locally.

One last question, since the FMV at the time this became a rental was likely to have been less than what was paid to originally purchase the home, is this going to be even worse or better? 

[ColeenD3]

No, the only thing this affects is the amount of depreciation you take upon conversion. You must take the lower of the FMV or adjusted basis for depreciation on conversion.

[aamedia]

Thanks. Some final questions.

I may not find anyone who can complete my taxes in time. If I estimate my taxes based on what I would have to pay without having claimed depreciation, make a partial payment and indicate the payment should be applied to an extension, will that work to buy me time? I'm getting this from the IRS site - here

Alternatively, can anyone comment on using TurboTax Live Full Service to get this done? If good, do they handle filing the extension? I have most of the return done. This is the only remaining issue.

[PattiF]

You should file an extension and send a partial payment with the extension. That will give you a six-month extension of time to file your tax return.

Form 3115 is available in TurboTax but it is unsupported meaning that we don't help with the filling out of the complex form. You need to contact a tax professional in your area to take care of the years of not depreciating your property.

[aamedia]

Thanks. I was able to find someone to correctly handle my taxes and the extention will be filed if necessary.

One another note, this person - who has 31 years of experience dealing with my type of situation indicated that the Form 3115 should not be filed. I've seen all sorts of articles and been given advice here from experts about using the form to fix the accounting method error and claim the prior years of depreciation. But I was advised that this is not correct. I'd like to find the best way to explain the 481(a) adjustment mentioned above. I suspect that my tax CPA may not understanding what I'm asking.

I considered the above and took at look at the Form's instructions. Does this apply to my situation as having sold the rental property in December 2021 as explained above?

"Depreciation or amortization (impermissible to permissible) (sections 56, 167, 168, 197, 280F, 1400I, 1400L, 1400N, and former section 168)—from an impermissible method to a permissible method for changes allowed under Regulations section 1.446-1(e)(2)(ii)(d), and for depreciable property owned at the beginning of the year of change. Complete Schedule E of Form 3115. An applicant changing its method of accounting for depreciation because of a change described in designated automatic accounting method change number 10 (sale or lease transactions) must file Form 3115 according to the designated change number 10. Additionally, a qualified small taxpayer qualifies for a reduced Form 3115 filing requirement. See section 6.01 of Rev. Proc. 2018-31."

When I looked up the 481(a) adjustment, I see this:

"Under current IRS rules, the calculation of depreciation or repair deductions for prior years can be recomputed, and a one-time catch-up adjustment (i.e. IRC §481(a) adjustment) is allowed in the current tax year for missed deductions. The adjustment is the difference between depreciation or repair deductions claimed versus depreciation or repair deductions that could have been claimed by the end of the prior tax year. This adjustment is reported on IRS Form 3115 and does not require amending any prior year tax returns."

Does this actually save me any $$ in taxes, or am I just correcting something to be technically correct that doesn't really help my bottom line? If this will help me, I'd like to pass on the above. At this point, I really want to get this filed without complicating things if the CPA has never done this. But if this will help me, 

[aamedia]

Thanks.

I found someone with 31 years of experience to work on my taxes by the deadline. However, she is saying that the 3115 is not applicable.  I did review the one time catch-up adjustment under IRC §481(a) and it seems like it would apply to me. Am I missing something or are there situations where the 3115 doesn't actually provide any real benefit?

I'm still thinking about the extension to be sure this gets done correctly without being a "rush job".

[ppff]

i bought the house in 2004 for residence at 210K, conversion rental house in 2013 and the fair market value(FMV) is 130k. and sold it at 300K in 2023. which number ( 210K or 13I 0K) for the cost basis to calculate the depreciation?

I use TT "Sale of Home (gain or loss)” to fill in the cost number and show me :

"Property converted to business use from personal use
If you used the item for personal purposes before you started using it in your business, the cost is the lesser of:
- The item's fair market value, or
- Your basis in the asset (how much you've paid for it, including whatever you spent to acquire it) at the time you started using it for business."

[RobertB4444]

If you didn't enter the depreciation at all back when you converted it in 2013 then you should enter the 130K amount - as long as you are confident in it.  If you are just guessing about that number then the cost that you paid for the property originally is a safer number.

@ppff