unallowed loss and depreciation recapture

[keon821]

Hi,

I am doing 1031 so gains are deferred. But I need to calculate the deferred gain, and thus the depreciation recapture.

I have been in high income category and my rental real estate depreciation has been considered unallowed loss.

Can I deduct the unallowed loss (the sum of all the unallowed depreciations over the many tax years) to calculate the depreciation recapture? I think it is the right thing to do because I am trying to recapture depreciation that was regarded as unallowed loss and had no impact to my personal income. Thus, these two (unallowed loss and depreciation recapture) go hand in hand.

But some said unallowed loss should not be a factor in calculating depreciation recapture. Then, how can I enter the unallowed loss info? Will it end up entering in Schedule 1, 8a (Net operating loss)?

Even so, my deferred gain will be incorrect without considering unallowed loss. That really puzzles me!

[GeorgeM777]

No you don't deduct the previously disallowed losses.  Rather, those losses carry forward to the replacement property in the exchange. You are correct in that you do need to calculate the depreciation recapture.  

Once you have finished entering your 1031 exchange in TurboTax, then you can begin the process of entering your carryover losses.  In TurboTax CD/download, you enter passive carryover losses as follows:

1. After opening your return in TurboTax, select the Business tab.
2. Under Business Income & Expenses, scroll down to Rental Properties and Royalties and select Start or Update.
3. Respond to the various screens.  When you get to the Rental Summary screen, select Property Profile.
4. On the next few screens, you will enter some basic information about your rental.
5. On the screen, Do Any of These Situations Apply to This Property? select the appropriate option under Carryovers.
6. Continue through the rest of the application and you should see the screen, Passive Losses From Prior Years.  
7. On aforementioned screen, you can enter your carryover passive losses.
8. Continue through the rest of the application. 

If you are using TurboTax online, follow these steps:

1. After signing in to your account, select Wages & Income in the left margin.
2. Scroll down the screen to Rentals, Royalties, and Farm.
3. Select Rental Properties and Royalties (Sch E)
4. Unlike TurboTax CD/download, from this point forward, you will have to act as if you rented the property even though you did not.  In fact, if you indicate on the relevant screen that the property was not rented in 2022, TurboTax will assume you have nothing to report.
5. After you enter information as if you have rented the property during 2022, you should see a screen which will indicate, among other things, that the application will now address Less common situations, such as carryover losses.
6. On the screen, rental property info, scroll down and select Carryovers, limitations, at risk info, etc. and enter your information about your carryover losses.  

@keon821 

[keon821]

Thank you, @GeorgeM777 

Are unallowed losses only indicated on Schedule E for real estate properties? I went back to the previous years of tax return to get the unallowed loss numbers from Form 8582. The numbers on 8582 are the actual amount of depreciation. The numbers on Schedule E weren't consistent because of some limitations. (often times it ended with 0.)

[keon821]

In addition, the difference between applying the unallowed losses now vs later to offset depreciation recapture is substantial.

Without using the unallowed losses to offset the depreciation recapture now, the cost basis for the new property is a lot lower. Coupled with the cost of land, it seems not right to have a tiny amount of depreciation of the property left. If I were to not do the 1031 exchange, I still have decent of property depreciation amount left.

Should the land value be adjusted some way to make this total depreciation amount more reasonable? For example, does applying a ratio based on property tax for premise/land to the total cost basis, or the difference in value between the two properties, make sense to do? or even the land value of the new property should be set to 0, because we are talking about cost basis and no land value has been in the calculation?

Thanks.

Keon