basis of rental property

[oceanlovin'ea]

Remember a while back I posted that I learned something new about the basis of a house that had been a personal residence and then turned into rental property. It is the LOWER of their adjusted basis or FMV at the time they convert to rental.

Well, I had this situation a couple of years ago and started depreciation based on FMV of the home at the time they started to rent it out. Now they have sold the rental property. Based on the fact that I overstated their basis in the house and land, they will have a much larger loss than they should have. I overstated the basis by about $15,000.

Now what do I do?

Linda, EA

[WhiteOleander]

I have never faced this issue. But, my idea would be to file form 3115 with the return. You can claim over-claimed depreciation and take the adjustment with the sale. Might work.

[taxea]

I have never faced this issue. But, my idea would be to file form 3115 with the return. You can claim over-claimed depreciation and take the adjustment with the sale. Might work.

I agree...make adjustments to the basis/depreciation on the sale form

[Koss]

Overstated Basis

The problem is that the adjustments will also have an impact on previous years, because depreciation is involved each year.

If the original error is within the three year window, then maybe you should file amended returns for each year that is affected.

You pretty much have to do an amended return for each year in order to accurately determine what the adjusted basis should be on the date of the sale...

If it's more than three years back, then I agree that Form 3115 is the right approach.

Got malpractice insurance? Just kidding

BMK

[oceanlovin'ea]

another one

now I have another one. New client who has been using Turbo Tax. He started renting house in 2010 (he thinks). He told me what he used for the basis but I can't come back to the figure on his 2011 return. so i can amend the returns.

This man is taking chemo and radiation treatments right now. I hate to bring this up to him but I know I have to. He said he always did his own but he just doesn't feel like he can think clearly right now. I guess not with what he is going through.

The original one is one I have done for years. She lived next door to me. Rented the house for a couple of years and sold it to my daughter and son-in-law last year. So I can fix hers......maybe not before the 15th. She won't get upset. :O

Linda, EA

[mastertaxguy]

Rental House basis

1. On your original post, you do not indicate what value you used, but seem to imply you used a larger figure than FMV.
2. Rather than filing amended returns and Request for Audit forms (also know as 3115's), I would be inclined to "adjust" the sale proceeds more to the land value than the structure, in effect washing it out.
3. IF the "correct basis" for depreciation is significantly large enough to significantly alter prior year losses, or significantly increase prior year gains, those who suggest amendments of prior year's returns are correct (of course). Recall that you can amend a return at any time to pay more tax.
4. Some might make an by altering expenses so as to, in effect, pick up the incorrect depreciation if that is the case.
5. What are you using for FMV if that was the correct figure? Was their an appraisal at the time? What evidence is there that whatever you used as basis is incorrect? Was there a change in use assessment change by local property tax assessors (you hint that was in Florida). At the time of change to rental, for how much was the property insured?

[Gary2]

I'm not sure that using the wrong value as the basis for depreciation is part of the accounting method (as opposed to a posting or math error), so I really don't see how 3115 would apply. Which code would you use?

Nor does the overstatement for depreciation purposes cause a larger loss. It causes a smaller loss. That's because the basis for the sale is not the same as the basis for depreciation. The basis for a loss is still the smaller of the original basis or FMV at the time of the change, minus the depreciation allowed or allowable, along with any other adjustments. In this case, allowed is what what actually taken, regardless of it being wrong. So the effect of using a basis that's too high for depreciation will only lower the adjusted basis for the sale, and thus decrease the loss (or, if there were a gain, increase it). It will also increase the amount subject to unrecaptured 1250 gain treatment.

Go to Pub. 551 and read the entire section on property changed to business use.

[oceanlovin'ea]

I used FMV for basis for depreciation. This is about $20,000 higher than their basis plus improvements. Property values went down in those 2 years that they rented the house out. So they sold it for less than the FMV that I used but more than their actual basis in the home.

So at the basis I used form depreciation they will have a loss but using their basis they would actually have a gain. Not that I am using that as a determination of how I proceed. It is just a statement of how this situation changes the outcome.

The code says to use lower of FMV or adjusted basis at time property is converted. So that is what I have to do. I will amend the returns and make the necessary corrections and try to explain my way out of this one. (maybe when tax season is over I should sit down and READ the whole TaxBook and see what else I can learn.)

Linda, EA