Question about Basis and Depreciation for a Rental Property

[jhmagill1]

I have rental property that cost $225,000 about 10 years ago.  Land was valued at $100,000 and building at $125,000, so the building is being depreciated using 27.5 years or $4,545/year, so accumulated depreciation is $45,450 and adjusted basis on the building is $79,550, + $100,000 for the land or $179,550 for the property.  In 2022 it experienced storm losses.  Insurance evaluated covered damages to the house of $70,000 and paid $64,000 after the deductible.  In addition, there was non-covered loss of the seawall that will cost $75,000 to replace.  A local appraisal valued the property at $645,000 before the storm and $510,000 after the storm, so I claimed a Casualty Loss of $135,000.  I did NOT adjust my depreciation schedule, so I need to amend my 2022 and 2023 returns.  I now realize that I need to reduce my basis by the Casualty Loss claimed, but that cannot be more than the adjusted basis.  Does this rule refer to the Property Basis, or the Building Basis?  I assume that if this reduction drives the basis to zero, the depreciation deductions stop.  Thanks for your recommendations.

[PatriciaV]

The casualty adjustment should be allocated to both the building and the land. The portion for the seawall repair obviously relates to the land. The balance would be used for the building.

You have the option to allocate the adjustment using any reasonable method. That could be the county appraisal, the value before the loss, or the actual expenses needed to restore each portion of the property.

Remember that land is not depreciated, so any adjustment would be applied only to the land basis.

[jhmagill1]

Thank you PatriciaV!  That is very helpful.

So, in my example, my land "basis" changes from $100,000 to $29,000 if I apply the full $71,000 Casualty Loss to the seawall.  When I replace the seawall, do I then simply "reverse" this adjustment?

Concerning the building, do I need to also reduce that basis by the $64,000 insurance payout?  This money was spent to restore the property (other than the seawall) to its pre-storm condition.  

Thank you again for your guidance!

[PatriciaV]

When you replace the seawall, you will add the cost of the "repair" to the basis of the land.

No, because you were reimbursed for the casualty loss, the basis of the building would be 1) reduced for the change in assessed value and 2) increased by the reimbursement you received.

You may wish to review IRS Pub 547 Casualties Insurance and Other Reimbursements